Investing in stocks can be very lucrative, but it is certainly not risk free. If you are thinking about investing in stocks you should be aware of a few important factors.
This Market Business News information article provides details on the different types of stocks there are, the risks associated with investing in the stock market, and how investing in stocks for the long-term may be a good option.
The types of stocks
It’s important that you fully understand what stocks are before investing your money in them.
When you buy a stock you become a stockholder, with a share of ownership in the company whose stock was issued to you.
There are two main types of stocks:
Common stock – owners of common stock are entitled to vote at shareholder meetings and receive dividend payments.
Preferred stock – owners of preferred stock do not have voting rights. However, they receive dividends before owners of common stock and are more financially protected if the company goes bankrupt.
Stocks may also fall into one or more of the these categories:
Blue-chip stocks – these are shares in major, established companies that have history of solid growth.
Value stocks – these are shares with a low price-to-earnings (PE) ratio, which means that they are cheaper than other stocks. People tend to buy value stocks in the hope that the price will rebound.
Income stocks – shares that consistently pay dividends.
Growth stocks – these are shares with earnings increasing at a faster rate than the market average. They do not usually pay dividends. However, people buy them in the hope of capital appreciation.
The risks of investing in the stock market
There are two main risks associated with investing in stocks. One has to do with stock volatility – the ups and downs of the price of a stock over time. However, the biggest risk is losing some (or all) of an investment in a stock due to serious decline in the business prospects of the company.
Volatility risk – This is the risk of selling a stock too soon, out of panic, because it dropped in price slightly – despite the value of the stock recovering soon afterwards.
Permanent risk to capital – It is possible to buy stock in a company that is in serious decline and permanently lose all your capital. If you are investing for the long-term it is better to not put all your eggs in one basket, spread out your investments, and focus on established blue-chip companies.
Stocks for the long-term
If you take a look at the historical trend of the Dow Jones market (below) you can identify that there have been various different market cycles.
However, despite fluctuations, the big picture shows that the market is trending upwards. Stock market growth over extended periods has been remarkably consistent.
From 1896 up to 2010, there have been four bull markets (shown in green) and four bear markets (shown in red). A bear market is one that is falling, while a bull market is rising.
But what does this mean? It means that if you hold onto investments in the stock market there is a high chance that in the future they will increase in value.
A good strategy of buying stocks for the long-term is to first of all spread your investments. This means investing in a number of different companies – not just one.
In order to play things safe and minimize risk, it is recommended to invest in at least 10 different blue-chip companies that have demonstrated history of solid growth, such as General Electric, Google, Apple, Samsung, Shell, etc.
Hold onto these investments for at least 15 years and you should expect significant capital gain.