Stock represents equity, or partial ownership, in a company. When you purchase a stock, you become a shareholder in the company that issued it.
Many companies offer shares of stock in their business on a stock exchange to raise cash. Investors can then buy and sell these shares among themselves. (Here’s more about the basics of the stock market.)
Stock owners share in the company’s profits and reap potential rewards, especially if they sell the stock after the value of the company — and the stock — climbs. Not every stock climbs, however: Stock owners can also lose all or part of their investment.
How to make money in stocks
Stocks carry more risk than some other investments, but also have the potential to reap higher rewards. Stock investors earn money in two main ways:
- If the price of a stock goes up during the time they own it, and they sell it for more than they paid for it.
- Through dividends, which are regular payouts of the company’s profits to its shareholders. Not all stocks pay dividends, but those that do typically do so on a quarterly basis.
Over the last century, the stock market has posted an average annual return of 10%. The word “average” is important here: Not only is that return an average for the market as a whole — rather than a specific individual stock — but in any given year, the market’s return can be lower or higher than 10%.
Investors who do best over the long term own a diversified portfolio of many stocks and hold on to them through good times and bad. That portfolio can be made up of individual stocks, or stock funds like index funds or exchange-traded funds.
» Ready to build your portfolio? Here’s how to invest in stocks
Key things to know about stocks
Have a 401(k)? You probably already own stock. Most employer-sponsored retirement plans, such as a 401(k) plans, invest in mutual funds, which can hold a large number of company stocks pooled together.
Not all stocks are equal. Most investors own “common stock” in a public company. Owners of “preferred” stock stand at the front of the line when it comes to dividend payments. If the company goes bankrupt, preferred-stock owners also receive any liquidation of assets ahead of common-stock owners. Preferred stock may offer higher yields, but it comes with different risks and restrictions.
Companies can also issue different capital classes of stock, such as Class A or Class B stock, with different values and shareholder rights.
Purchasing stocks is like an auction. A common stock sold on a stock exchange was once sold much like auctioneers taking bids at a market. Now algorithms do most of the heavy lifting, but the basics of buying a stock are same: Stocks are sold at a price agreed to by buyer and seller; that price can fluctuate over the course of a trading day.
Investing in individual stocks takes time. You should research each stock you purchase, which includes a deep dive into the bones of the company and its financials. Many investors opt to save time by investing in stocks through equity mutual funds, index funds and ETFs instead. These allow you to purchase many stocks in a single transaction, offering instant diversification and reducing the amount of legwork it takes to invest.
To buy stock, investors typically need to open a brokerage account. A brokerage account gives you the ability to buy stocks in individual companies or as part of mutual funds, and lets you purchase other investment vehicles. The process of opening one is similar to opening a bank account. Brokerages charge different commissions for stock trades, so it’s important to shop around. Here is NerdWallet’s list of the best brokers for beginner stock investors.