What Are Stocks?

When you open an investment account, you can choose from a variety of investment types. The most common type of investment is stocks. But what are stocks? They’re a type of security that represents partial ownership in a company. Investing in stocks has the potential for significant growth, but you should be aware of the risks of investing in the stock market before investing your money. 

What are stocks? 

Stocks, also known as equities, are a type of investment that gives you ownership of a company. For instance, you can buy stocks and become a shareholder of major companies like Amazon, Apple, or the Walt Disney Co. As a shareholder, you share in the company’s profits and losses. 

How do stocks work? 

You can buy stock for any publicly traded company, meaning a company whose shares are traded on the stock market. Companies issue stocks to raise money to pay off debt, launch new products or expand to new markets. 

To buy and sell stocks, you usually need to work with a broker. Brokers handle stock trades for customers for a fee. Shares of stock are sold on the major stock exchanges, such as the New York Stock Exchange (NYSE) or the Nasdaq. 

As a shareholder, you can earn money through stocks in two ways: 

• Capital appreciation: Over time, your stock’s price may increase. For example, if you bought a share of stock in 2022 for $500 and it’s worth $600 in 2023, your stock appreciated in value and you have $100 in gains. 

• Dividend payments: Some companies will pass on a portion of their profits to shareholders in the form of dividend payments. For example, a company may pay a dividend of 20 cents per share every quarter. If you own 100 shares, you’ll get $20 in quarterly dividend payments.

Stock prices can change a great deal over time, and even within a few hours. Factors affecting stock prices include the following: 

• Demand: The more that people want to buy a particular stock, the higher its price will be. Well-known companies or ones that generate a lot of buzz over new products can generate significant demand, causing their prices to rise. 

• Profits: When a company performs well and is profitable, investors are more confident in that company’s future, and its stock price will increase. Conversely, companies that are struggling financially tend to experience price drops in their stock. 

• Overall market: The price of a stock largely depends on the performance of the overall stock market. When investors are worried about potential recessions or inflation, stock prices tend to drop. Similarly, prices usually increase when the economy is strong. 

Types of stocks

There are two main kinds of stocks: 

Common

Common stock are the most-commonly used stocks. They entitle shareholders to vote at shareholder meetings, and shareholders are eligible to receive dividends.

Preferred

Shareholders who own preferred stock usually can’t vote at shareholder meetings. But they receive dividend payments before common stock shareholders and have priority over other shareholders if the company fails and its assets are liquidated. 

Within those two main categories, stocks are typically classified in the following ways:

Growth stocks

A growth stock is a company that is expanding or becoming profitable at a faster rate than the rest of the market. These stocks have the potential for higher returns, but because they’re focused on growth, the company usually reinvests its profits rather than pay out dividends. 

Income stocks

Income stocks are companies that provide a consistent form of income, usually in the form of dividend payments. 

Value stocks

Value stocks are companies that are currently priced below what investors believe is their actual value. Investors may buy these stocks because of their potential value in the future. 

Blue-chip stocks

Blue-chip stocks are established companies with proven track records of providing returns. 

Stocks vs bonds

Like stocks, bonds are a common investment option for many investors. But unlike stocks, bonds are debt securities. The issuer sells bonds to raise capital for its projects or to expand its operations. In return, the issuer promises to pay bondholders interest for a specific period. And once the bond matures, the issuer repays the bond’s principal. 

Bonds are generally considered a safer investment than stocks because you can earn a steady return and get your principal back. But they typically produce lower returns than stocks. For example, an investment portfolio that’s 100% invested in bonds has an average annual return of just 5.33%. By contrast, the average annual return for a portfolio 100% invested in stocks is 10.29%.

Due to the power of compounding, investing in stocks rather than bonds can allow your money to grow substantially more. 

For example, let’s say you’re 25 and can invest $100 per month. If you invested only in bonds and earned an average annual return of 5.33%, you’d have $166,424 by the time you turned 65. You’d contribute a total of $48,000, and your money would grow by $118,424. 

But say you decided to put your money entirely in stocks instead. If you invested $100 per month and earned an average annual return of 10.29%, your account would be worth $690,927 — significantly more than if you invested in bonds. 

Try our compound interest calculator to see for yourself!

Investing in stocks

Before you invest in stocks, it’s critical to understand the benefits and risks of the stock market. 

Pros

• There is potential for growth: On average, stocks have a higher return than other investment types, such as bonds or certificates of deposit (CDs). Over time, investing in stocks can produce more profits. 

• Stocks may outpace inflation: Over time, inflation can erode the value of your savings. Investing in the stock market is key to outpacing inflation so you can have a comfortable nest egg later on. 

• Stocks provide liquidity: Investing in stocks, mutual funds and exchange-traded funds (ETFs) gives you more liquidity than other options. You can buy or sell shares at any time; you don’t have to keep your money tied up in an account for a specific period of time like you do with CDs or Treasury bills. 

Cons

• There is a level of risk: Although investing in stocks has historically provided positive returns, there is always some risk involved with investing. The market can fluctuate a great deal. For example, the S&P 500 — an index that tracks the performance of 500 of the largest companies in the U.S. — is down roughly 12% year-over-year as of early 2023. You can lose money, and it can take years for the market to recover. 

• Capital gains taxes: When you invest in stocks and the price increases, you have to pay capital gains taxes on the profits you earn after selling the stock, which reduces your returns. 

• Stress: Investing can be stress-inducing for many people. The stock market can be volatile, so it’s possible for your portfolio to drop in value by hundreds or thousands of dollars overnight. 

Taxes on stocks

When you sell a stock for more than you paid, a “capital gain” occurs, and you have to pay taxes on stocks for the difference between the original price and the sale price. You have to report those earnings on your tax return when you file your federal and state income taxes. 

The tax rate depends on when the stock was sold: 

Short-term capital gains

If you’ve held a share of stock for one year or less at the time of its sale, you’ll have to pay short-term capital gains. The short-term capital gains tax rate ranges from 10% to 37%; the rate you pay depends on your filing status and household income. 

Long-term capital gains

Long-term capital gains apply to stocks you’ve sold after holding them for more than one year. The tax rate for long-term capital gains ranges from 0% to 20%, depending on your filing status and income. 

How to invest in stocks

To start investing in the stock market, follow these steps: 

1. Open a brokerage or investment account

A brokerage account or an investment account is necessary to buy stocks, bonds, mutual funds and ETFs. With a platform like Acorns Invest, you can open an account for as little as $5 per month. Acorns will ask you questions about your goals and create a personalized portfolio for you. 

2. Decide on a strategy

There are many different investment strategies to choose from. But for most, using a combination of dollar-cost averaging and buy-and-hold investing is a solid, long-term approach. 

• Dollar-cost averaging: With dollar-cost averaging, you invest at regular intervals, no matter how the stock or fund is performing. For example, you might invest $10 every Friday. This approach can lower the amount of risk you take on by balancing out market highs and lows. 

• Buy and hold: Long-term investors focused on goals like retirement often use a strategy called buy-and-hold investing. They invest in stocks or funds and hold onto those investments for years or even decades. This strategy is based on the historical long-term returns of the stock market and confidence in your investments. 

3. Diversify your investments

Diversification is a strategy where you invest in different types of securities. Putting your eggs in multiple baskets can help minimize the risk of losing all of your money. The returns of some of your investments can offset the losses of others. If you’re investing on your own, you can diversify your portfolio by investing in a variety of individual stocks or bonds. 

However, investing in mutual funds or ETFs can be a better strategy. These types of investments are made up of hundreds or even thousands of stocks and bonds, so you get exposure to a lot of companies with a single investment. 

If you’re using a robo-advisor platform like Acorns, the platform matches a portfolio of ETFs to you based on your goals and risk tolerance. It eliminates the work of researching individual stocks, and it automatically adjusts and rebalances your portfolio. 

4. Set up recurring investments

The stock market isn’t a way to get rich overnight. Growing your money takes time. But you can help build a foundation for financial independence by setting up regular contributions to your investment account. Over time, even small amounts can add up. 

5. Stay the course

It can be tempting to check on your portfolio regularly to see how it’s performing. But the market can be volatile, so your portfolio’s value can vary dramatically from day to day. If you see a significant drop in value, you may be tempted to sell the remainder to protect what’s left. But try and fight that impulse. The market naturally ebbs and flows, but if you focus on long-term results, you’ll find that your money is typically better off being left in the market.