Stock investment has historically been one of the simplest and consistent ways to build wealth over the long term. Although Hollywood films have often depicted stock investing with the highs of overnight successes, along with the low of catastrophic failures, your experience doesn’t have to be as volatile.
If you approach stock investment intelligently, you can avoid the common pitfalls and benefit from shrewd investment decisions.
What Is A “Stock”?
The simplest way to describe a stock is by saying that it represents a single unit of ownership in a company. This means that when you purchase a stock, you effectively own a piece of that company.
A stock entitles you to a share in the company’s profits, assets and voting rights. There are 2 kinds of issued stock:
- Common Stock – this gives the stockholder voting rights, however, there is no guarantee on dividend payments
- Preferred Stock – this gives the stockholder priority when it comes to dividend payments. Also, in the event the company is liquidated, preferred stockholders have a claim over the company’s assets.
These days, stock ownership is recorded electronically and held by your broker. In the past, paper stock certificates were issued to you, and these were used to verify the number of stocks that you owned.
How Do I Make Money From Stock Investment?
When purchasing stocks, investors aim to make a profit in two ways:
- An increase in stock price – also known as ‘capital gain’ or ‘capital appreciation’. This simply means making a profit by buying stocks at a certain lower price and selling it at a higher price.
- A share in the company’s profits – this are referred to as dividends
Is It Risky to Invest in Stocks?
All types of investments have inherent risks associated with them and stock investment is no different. Here are ways to mitigate this risk:
- Avoid investing all of your funds into one stock – placing all your money into one stock is a high-risk strategy. There is a high potential that you lose all your money. Instead, consider spreading the risk across different companies and sectors
- Do your homework on the companies and industries you are considering – this will ensure that they are on a sound financial base
Getting Started Investing in Stocks
Some questions to consider before investing in stocks:
- What are your goals for investing?
- How long do you want to hold your stock investment for?
- How much money do you want to invest in stocks?
- What are your attitudes towards risk? Are you comfortable with volatility?
Answering these questions will give you a better idea on the type, quantity, and total dollar value of stocks you will invest in.
How to Purchase Stocks
The most common way to purchase stocks is through a brokerage account. Nowadays, these accounts can range from online brokerage accounts for those who want to “do-it-yourself”, to full service brokers who can provide individual advice and suggestions.
Typically, online brokerage accounts will have low cost brokerage fees, while full service brokers have a higher brokerage fee. The type of broker you choose will ultimately depend on your goals and investment strategy.
If you are a trader with a high volume of transactions, then an online broker may be more cost effective for you. If you are a “buy and hold” investor, then you might be able to justify the higher brokerage cost, since you may value the suggestions and research.
Other ways of purchasing stock include:
- Through a 401k plan
- Through an individual retirement account (IRA)
- Through a direct stock purchase plan
How to Invest In Stocks
If you can pick the right stock, it will make a big difference to the performance of your investment portfolio in the long term. Fundamental analysis is the most used approach for doing this.
Fundamental analysis involves analyzing the company’s financial statements, the business operations, it’s competition and the economic environment.
Three financial statements to look at are:
- Income statement
- Balance sheet
- Cash flow statement
The goal of this is to determine if the company’s future outlook is positive. Questions to help determine this include:
- Is there a demand for the company’s goods and services in the future?
- Can this company grow further?
- Does the company have a strong position compared to its competitors?
As you can see, with a little bit of research and analysis, you can avoid making costly investment mistakes, while maximizing your profit potential. Armed with the right knowledge, you can stand to make yourself wealthy in the long-term with stock investment.