You know you need to invest in stocks for growth. But which types of stocks?
Stocks are classified in a few ways. There are two basic types of stock — common and preferred — and within those categories, stocks are also grouped by other factors, including company size, industry, location and growth potential.
Types of stocks: Common and preferred
A stock is an investment in a company. When you own a stock, you own a share of that company’s earnings and assets. When a company sells shares of stock to the public, those shares are issued as either common stock or preferred stock.
- Common stock is exactly what the name implies: The most common type of stock. Most investors who own stock own common stock. When you own common stock, you own a share in the company’s profits as well as the right to vote. The way voting rights are structured can vary, but commonly, shareholders get one vote per share owned. Common stock owners may also earn dividends, but those dividends are typically variable and not guaranteed.
- Preferred stock is frequently compared to bonds, because it typically pays investors a fixed amount on a regular basis. That fixed amount is called a dividend. Preferred shareholders get preferential treatment: Dividends are paid to preferred shareholders before common shareholders, including in the case of bankruptcy or liquidation. That’s not to say preferred shareholders can’t lose money: Preferred stock prices are less volatile than common stock prices, which means shares are less prone to losing value, but they’re also less prone to gaining value. In general, preferred stock is best for investors who prioritize income over long-term growth. (If you’re eyeing stocks for income, read about how to invest in dividend stocks.)
Companies might also divide their stock into classes, in most cases so that shareholder voting rights are differentiated. For example, if you own Class A of a certain stock, you might get more voting rights per share than owners of Class B of the same stock.
» Ready to invest? Read our guide to how to buy stocks
Categories of stocks
The best portfolio is a diversified portfolio, and that means spreading your money not just between stocks and bonds, but also among different categories within that broader allocation.
Stocks are categorized in many ways. Here are some of the most common:
You might have heard the words large-cap or mid-cap before; they refer to market capitalization, or the value of a company. Market capitalization is calculated by multiplying the total number of a company’s shares outstanding by its current share price.
Companies are generally divided into three buckets:
- Large-cap, with market value of $10 billion or more.
- Mid-cap, with market values between $2 billion and $10 billion.
- Small-cap, with market values between $300 million and $2 billion.
Though used less frequently, you might also hear the terms micro-cap (under $300 million) and mega-cap (over $200 billion). Market cap can give you some insight into how risky a company might be and how much potential for growth there is. Generally, small-cap companies are considered riskier, but may have more potential for growth.
Companies are also divided by industry, often called sector. Stocks in the same industry — for example, the technology or energy sectors — may move together in response to market or economic events. That’s why it’s important to diversify across sectors. (Just ask someone who held a portfolio of tech stocks during the early 2000s dot-com crash.)
There are 11 stock market sectors:
- Communication services
- Consumer discretionary
- Consumer staples
- Health care
- Information technology
- Real estate
Stocks are frequently grouped by geographic location. You can diversify your investment portfolio by investing not only in companies that do business in the United States, but also in companies based internationally and in emerging markets, which are areas that are poised for expansion. (Here’s more on how to invest in international stocks.)
You might hear stocks described as growth or value. Growth stocks are from companies that are either growing quickly or poised to grow quickly. Investors are typically willing to pay more for these stocks, because they’re expecting bigger returns. As a result, their stock prices tend to be high.
Value stocks are essentially on sale: These are stocks investors have deemed to be underpriced and undervalued. The assumption is these stocks will increase in price because they’re either currently flying under the radar or suffering from a short-term event.
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Which stock types are right for you?
The most important consideration when choosing a stock isn’t necessarily its category, but whether you believe in the company’s long-term growth potential and whether the stock complements the other investments you own.
Mutual funds are the easiest way to build a diversified portfolio.
But if the idea of assembling individual stocks into a diversified portfolio seems daunting — and it certainly can be — you might want to consider stock mutual funds.
Mutual funds are the easiest way to build a diversified portfolio. These funds allow you to purchase many stocks in a single transaction. Many mutual funds invest in a specific category of stocks — for example, you can purchase a growth mutual fund that invests in growth stocks.
Some mutual funds employ a professional investor to pick and choose investments and manage the portfolio. Our preference is low-cost index funds, which track a section of the market — such as large-cap stocks — without that professional oversight by following a benchmark index. For more about index funds, read our full explainer.