What are stocks?
Editorial staff, J.P. Morgan Wealth Management
- Stocks represent small pieces of company ownership that can be bought and sold by investors.
- Companies issue stocks as a way of raising money to fund their growth plans, while investors typically buy stocks hoping they will increase in value.
- While there’s a level of risk that comes with stock trading, stocks have the potential to generate investment returns.
- Consulting a financial advisor can be beneficial in starting your journey with stock market investing.
The stock market can be a daunting subject to learn about. Some may write it off as too complicated to even try, and why not just open a savings account and be done with it?
While the world of stocks is not a simple one, potential investors may find it’s a lot easier to get started than they thought. Buying a stock can be as easy as opening an app.
Choosing a stock? That’s another story, but also not exactly rocket science. Understanding basic financial concepts such as profits and losses can help you begin to evaluate investment risk, stock valuation and other factors. Investing in stocks involves risks, including the potential loss of principal. Past performance is not indicative of future results.
For now, though, let’s start with the basics: What are stocks?
What is a stock?
A stock represents partial ownership in a company. For example, if you buy JPMorgan Chase & Co. (JPM) stock, you own a percentage of the company. How many shares you own determines the amount of equity you have.
How do stocks work?
Although privately held companies may offer shares of equity ownership – often to founders, employees and early-stage investors – when you hear about “the stock market,” it typically refers to stocks that are available for trading on public markets. After a company goes public, in what’s known as an initial public offering (IPO), the general investing public is able to purchase and resell shares of the company on the stock market.
“The stock market” is a bit of a colloquial term, given there are multiple stock markets across the world. The biggest stock markets in the U.S. are the New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotations (Nasdaq). These two New York-based exchanges host the stocks that make up the S&P 500, or the 500 “leading” companies in the U.S. economy. Which exchange you use depends on the companies you invest in.
To buy stocks, you need a qualifying account with a financial institution. For example, you can trade stocks using a standard brokerage account, a retirement account like an IRA or an array of other account types that can help you leverage increases in stock prices to reach your financial goals.
How stocks can generate investment returns
The process of buying a stock in itself can be simple. Once you decide on the stock to buy, you can often make the transaction with the click of a button. Many brokerages offer mobile apps and may allow investors to buy “fractional shares” – meaning if you don’t have the money to buy an entire share of a company you can still invest in it.
After investing, you may want to hold onto the stock so its value can grow. Stock values may increase or decrease over time, depending on various factors such as company performance and market conditions. You have the option to sell your publicly traded stock at any point, usually with the goal of making a profit (in this case called capital gains). Be aware of potential tax implications when selling stocks, as capital gains taxes may apply.
Beyond their potential to increase in value, some stocks provide an additional benefit in the form of dividends – a portion of the company’s profits that may be distributed to stockholders on a regular basis. However, not all stocks pay dividends.
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Classifying stocks
Stocks can be broken down based on a variety of different characteristics, and the kinds of stocks you choose to invest in can be influenced by your goals as an investor.
Types of stocks
There are two principal types of stocks most often issued by public companies:
- Common stocks: The class of stock that investors generally buy most often, common stocks typically give investors the right to vote at shareholder meetings on key company decisions like electing members to the board of directors. Holders of common stock may or may not receive dividends, depending on the type of company and its profitability.
- Preferred stocks: Preferred shareholders receive dividends before those who own common stocks. They also have priority if the company goes bankrupt, so they’re likelier to get their investment back. However, they don’t usually have the right to vote at shareholder meetings.
Stocks that align with different investment styles
It is also possible to categorize stocks using an array of other factors. You may hear stocks characterized by their market capitalization – or the total value of all a company’s outstanding shares – a key gauge of the stock’s value and a company’s overall size. Other times, stocks may be broken down based on profiles that correspond with different types of investment focuses and objectives:
- Growth stocks: Stocks with a higher rate of growth than the market average. These are often startup companies and may not pay dividends. While they carry higher risk, they also have the potential for significant returns.
- Value stocks: Stocks with a low price-to-earnings (P/E) ratio. They’re cheaper to buy than stocks with higher P/E, which reflects the fact that they may not be a hot commodity on the market. Investors in value stocks may look at them as opportunities for profits if they think the stock price will rebound.
- Blue-chip stocks: Stocks from large companies with a long history of growth. They may pay dividends and are generally considered to have lower risk compared with other stocks, though all investments carry risk.
- Penny stocks: Stocks from small, typically less-established companies that trade at or under $5 per share.
Each category of stock carries different levels of risk and potential reward. It is important to understand these differences before investing.
Pros and cons of stocks
As with any financial move, there are pros and cons to investing in stocks. One big plus is the chance to grow your money over time. This can make it easier to reach milestones like homeownership or retirement.
On the other hand, there is always the risk of losing money – no investment guarantees a return. So aside from doing personal research, potential investors may also benefit from talking to a financial advisor about their investing goals.
Pros of investing in stocks
- Potential for returns
- Potential for steady dividend income
- Liquidity (stocks are generally liquid, meaning you can typically sell them during market hours, but market conditions can affect the ease and price of selling)
- Diversification opportunities (you can invest in all kinds of companies across different industries)
Cons of investing in stocks
- Market volatility (your portfolio value can go up or down at any moment)
- Potential for loss
- Requires research and knowledge (to make investments that align with your goals)
How do you choose stocks?
The process of selecting stocks to invest in looks different for everyone. If the idea of it intimidates you, or the research involved makes you hesitant to invest, it may be helpful to talk to a financial advisor who can provide more tailored guidance based upon your financial situation.
For those who prefer to go through the process themselves, here are some steps to follow that can help determine which stocks may be right for you:
- Consider your investment goals, appetite for risk and time horizon: These factors can point you in the direction of where to put your money. For example, if you’re retiring relatively soon and want a lower chance of losing your investment, you may want to stick to blue-chip stocks with a solid history of growth.
- Research stocks and companies: Based upon your goals, it can be useful to research the stocks you’re most interested in. Part of this process can include:
- Analyzing financial statements
- Evaluating stock valuations
- Monitoring performance
- Look at industry and market trends: Which way is the market moving? What are successful people investing in? Keeping up to date with market trends can help inform your investments. However, market behavior can be unpredictable and erratic – such as what happened during the meme stock frenzy of the early 2020s. Before jumping on a trend, investors may want to ask themselves if they’re being driven by emotion or logic, and if the investment truly aligns with the goals they’ve established.
Stock alternatives
If you want to invest your money but you’re cautious of buying stocks, you have other options. These options also work if you already own stocks but want to explore other assets. Financial advisors often encourage clients to invest in multiple types of assets, as this can lower your risk of losing money in the event one asset class performs poorly.
Here are some common stock alternatives:
- Bonds: Bonds are essentially loans that you give to a company or government entity. In exchange, the loanee will pay you interest at regular intervals and pay back the principal (loan amount) at the bond’s maturity date. Most bonds are long-term investments and are considered safer than stocks, especially if bought from the government.
- Mutual funds: Instead of buying a single stock or bond, buying into a mutual fund allows you to invest in a pool of many. Mutual funds typically comprise multiple stocks, multiple bonds or both, and this diversification can help mitigate risk. Unlike stocks, mutual funds can only be traded at the end of a market day.
- Exchange-traded funds: An exchange-traded fund (ETF) is a lot like a mutual fund in that it’s made up of multiple securities, like stocks and bonds. There are some differences in fund management and taxes, and ETFs can be traded at any time of day.
- Savings accounts: Savings accounts, particularly high-yield savings accounts, are another way to earn interest on your money. With many financial institutions, you can even earn compound interest. These assets are easily accessible and very safe, but they usually won’t generate the type of returns seen on the stock market.
These alternatives also carry risks and may not be suitable for all investors. Consider your financial goals and risk tolerance.
The bottom line
Asking “What are stocks?” is the first step for many in a lifelong journey of investing. While there are pros and cons to stock trading, there’s a reason so many people do it: to help achieve their financial goals and dreams.
Consulting with a financial advisor can give you a better picture of how stock market investing works and how you, personally, may want to invest. No matter who you choose to talk to, getting informed and creating a plan can set you up for a positive introduction to investing.
Frequently asked questions about stocks
To invest in stocks, you must open a trading account (brokerage account) with a financial institution. Then you will be able to transfer money to the account and use it to buy stocks on an exchange like the NYSE or NASDAQ. You can trade stocks via computer or phone, and it’s often as simple as the click of a button.
Stock options are contracts that give investors the right to buy or sell a stock or ETF at a set price by a certain date. They are often the choice of more experienced investors who want to manage shifting market conditions with the security of a contract, which locks in a price for a certain amount of time.
There are two main ways to make money with stocks. One is by investing in dividend stocks, which pay out dividends at regular intervals (often quarterly) to shareholders. The other is by selling stocks when they’re priced higher than what you bought them for. Using this method, investors may want to keep in mind short-term capital gains tax, which is steeper than the long-term tax and can be applied to any stock you sell within a year of buying it.
Getting good at reading stock charts can take time and practice. But the first step is understanding the basic components. The left side of the chart (y-axis) shows the stock price in dollars; the bottom (x-axis) shows time passing within a certain period. This gives you the chart progression, where you can see if the price of a stock went up or down over that time and any shifts that happened along the way.
A meme stock is a stock that goes viral on social media, which in turn influences its share price. This happened most notably with GameStop and AMC in 2021, when retail investors started a social media buying campaign that caused a huge spike in stock prices.
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Editorial staff, J.P. Morgan Wealth Management
