When a company decides it needs to raise money to fund future growth, it can borrow or it can issue stock. Because investors who buy stock actually own a piece of the company, stocks are also known as equities and the stock markets are often referred to as the equity markets.
When you invest in the U.S. stock market, you become a shareholder in American industry. You stand to profit when the company you invest in does well. You also get to vote on certain matters of important policy.
There are two ways to make money on a stock: You come out ahead if a stock’s share price moves higher than what you paid for it. If the company pays dividends, you can collect them as income or reinvest them to buy more shares.
There are two basic types of stocks: common and preferred. Common stock is more risky: there are no guarantees that shares will rise in value or that dividends will be paid. Preferred stock typically comes with a stated dividend. However, the dividend doesn’t increase even if the company’s profits rise, and the price of preferred stock typically increases more slowly.
As a shareholder, your potential for gain is unlimited. But a stock can also lose value. If a stock falls out of favor, company profits decline, or competition edges out the company, a stock’s price could sink and you could lose money. In fact, sometimes the entire stock market takes a dive in reaction to national or world events or economic news. Yet, despite the volatility of the stock market, stocks have been the best-performing asset class for more than 100 years.
Dow Jones Industrial Average 1986-2007*
Managing volatility through mutual funds
One way to manage the risk of investing in the stock market is to invest in a broad range of companies in different industries. But it’s a challenge for most investors to own enough stocks on their own to achieve the diversification they need. That’s why millions of investors buy stock mutual funds. Stock funds make it easy to participate in the stock market because an investor generally doesn’t need much money to get started. Stock funds are professionally managed and shares are easy to buy and sell.
*Source: Dow Jones and Company. Market conditions during the periods varied from depression to robust growth. It is not possible to invest directly in an unmanagedindex such as the Dow Jones Industrial Average. Past performance is not a guarantee of future results. The Dow Jones Industrial Average represents share prices ofselected blue-chip industrial corporations as well as public utility and transportation companies.