A stock is an investment. When you purchase a company’s stock, you become a shareholder in that company.
What is stock?
Stock represents equity, or partial ownership, in a company. 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.
Of course, not every stock climbs: Companies can lose value or go out of business completely. When that happens, stock investors may lose all or part of their investment. That’s why it’s important for investors to spread their money around, buying the stock of many different companies rather than focusing on just one.
How to purchase stock
Companies raise cash by selling shares of stock in their business on a stock exchange, like the Nasdaq or the New York Stock Exchange. Investors can then buy and sell these shares among themselves. The stock exchanges track the supply and demand of each company’s stock, which directly affects the stock’s price. (Here’s more about the basics of the stock market.)
Most investors interact with stock exchanges through an account at an online broker. You’ll tell the broker what you want to buy or sell, and the broker will place the trade on your behalf. A broker will also give you access to other investments, like mutual funds.
» Ready to learn more? Read our detailed tutorial on how to buy stocks.
The process of opening a brokerage account is similar to opening a bank account. The commissions charged by online brokers for stock trades vary, so it’s important to shop around. Here is NerdWallet’s list of the best brokers for beginner stock investors.
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.
Types of stocks
There are two main types of stocks: common and preferred.
- Common stock: Most investors own common stock in a public company. Common stock shareholders have voting rights, which means they can influence the direction of the company (shareholders typically receive one vote per share). Common stock may pay dividends, but dividends are not guaranteed and the amount of the dividend is not fixed.
- Preferred stock. Owners of preferred stocks don’t have voting rights. But preferred stocks typically pay fixed dividends, so owners can count on a set amount of income from the stock each year. Owners of preferred stock also stand at the front of the line when it comes to the company’s earnings: Excess cash distributed by dividend is paid to preferred shareholders first, and if the company goes bankrupt, preferred-stock owners receive any liquidation of assets ahead of common-stock owners.
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.
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.
Stocks are a key part of a long-term investment portfolio. If you’re investing for a long-term goal — such as retirement — stocks should make up a large part of your investment portfolio. Stock index funds or ETFs — or a well-diversified portfolio of individual stocks — will help you outpace inflation and grow your money over time.