Investing in stocks can be an efficient way to build wealth. You can probably make a lot more money by investing wisely and patiently in stocks over a long period than you can with most legal methods.
Companies issue stocks (also called shares) to raise capital (money). If you buy some shares, you become a part-owner of the company. You get equity in the company and are entitled to a part of the company’s profits.
Stocks are of two types – common and preferred. Ownership of common stock entitles you to a share of the company’s profits and losses. If you own preferred stock, it assures you of getting fixed dividends. When we say “stock”, we are referring to common stock.
Risks and rewards
Investors earn money from stocks in two ways. Either the share price increases or the company distributes its profits as dividends.
Consider Microsoft stock, which has the trading symbol MSFT. Its share price was $170 in February 2020 and $280 in February 2022. So, if you had purchased Microsoft shares in Feb 2020 and sold them 2 years later, you would have made a profit of 65%.
Microsoft also pays a dividend of approximately 1% of the share price every year. So, overall, if you have been a Microsoft investor, you would have done pretty well.
In the Microsoft example, the company did well, and you made a profit. Let’s look at another example of a blue-chip stock – Unilever (UL). The stock price of Unilever for the same time frame was $60 and $52. You would have lost money.
These examples highlight the risks and rewards of buying stocks. What causes stock prices to rise or fall? The short answer is that nobody really knows, not even Warren Buffett! There can be many factors. Ultimately, if the stock has more buyers than sellers, the price increases. If there are more sellers than buyers, the price decreases.
Alternatives to individual stocks
A security is any financial instrument (product) that can be sold in a financial market. Stocks are a type of security (others include mutual funds and bonds).
Investing in individual stocks can be risky. You could lose your entire investment or go for years without making a profit. However, you can increase your chances of success by investing in stable, well-managed, and high-performing companies. Or, you could invest in mutual funds, which place your money in a basket of stocks, reducing your risk. The caveat is that risk and reward are complementary.
Note: Please do not invest money or assets in the financial markets that you cannot afford to lose. This article should not be construed to be investment advice and is for information purposes only