The Basics of Stock Investing
The ability to invest in stocks may well be one of the most beneficial opportunities that exists for individuals in an economy that incorporates characteristics of capitalism. Investing in stocks, or equity, gives individual investors ownership of a piece of a company and, as a result, the right to the profits of that company.
Publicly traded equity enables people to participate in every facet of economic benefit. Most working adults are automatically participants in the economy in two major ways: as an employee and as a consumer. As an employee, a person is paid by a company for contributing value; as a consumer the same person benefits from the ability to improve his or her quality of life by purchasing products and services that are valuable to that individual. Investing in stocks completes the circle, by making that same person an actual owner of the very same companies that pay employees and sell products and services. Anyone and everyone who can put even a small part of their paycheck each month into an investment portfolio is able to participate in the benefits of technological innovation, consumer trends, and long-term economic growth, thanks to stock ownership.
Shares of equity are created and sold by companies that are typically raising cash to make capital investments or to allow founders and early investors to sell and monetize their ownership stake. Additionally, a company can create shares to give ownership stake to employees for compensation and incentive alignment. Each share of equity gives the holder a right to a specific amount of ownership in the company, and generally provides certain voting rights to influence major decisions that the company makes. Once this stock becomes publicly traded, investors can buy shares from and sell shares to other investors. Each transaction requires a buyer and a seller, and the fundamental principal that markets are well-functioning and generally efficient is based on the fact that, given all available information, one party is willing to buy at the transaction price, and another party is willing to sell at that same price. This transaction price gives the stock price quote at any given time.
The benefits of owning the equity of a company also come with risk. Numerous factors can contribute to poor company performance and financial distress. These factors can be economy-wide, industry-specific, geographical, or idiosyncratic to a single company. Recessions, pandemics, financial crises, commodity price fluctuations, technological disruption, and poor management decisions, among numerous other factors, could contribute to a company facing a liquidity crisis or insolvency. When a company finds itself unable to pay its debt obligations, it may have to undergo restructuring through bankruptcy or liquidation, in which case debt holders take priority over equity holders. Just as shareholders receive all the value of a company that exceeds its debt, those shareholders also generally receive nothing if the value of the company is at or below the amount of its debt obligations.
Diversification is the crucial tool that investors have to deal with risk that is specific to a certain industry or company. When constructing the stock portion of a portfolio, it is important to incorporate equity investments from a diversified array of industries, geographical locations, and market capitalizations in order to both reap the benefits of equity ownership and mitigate the impact that a single piece of legislation, international trade conflict, poor management decision, or technological disruption could have on a company’s performance, and then by extension, the investor’s portfolio.
Mutual funds and exchange-traded funds (ETFs) are two types of investment vehicles that can assist in achieving this necessary diversification in an efficient manner. Stocks can provide returns that are very beneficial to the individual investor, and deliberate consideration should be put into constructing and implementing a portfolio that is allocated to meet the investor’s goals, risk tolerance, and investment time horizon.
Anthony Winkels is a managing partner and wealth advisor at Fortis Wealth Management
Disclaimer: This article does not constitute financial advice and should not be construed as such. Investing involves risk of loss of principal. Speak with a fiduciary financial advisor to determine the appropriate investment portfolio strategy for your financial goals, risk tolerance, and time horizon.
