Stocks, also known as equities, are shares of publicly listed companies in the stock exchange.
When you buy a company’s share of stock, you become a shareholder of the company.
Your equity interests in the company are determined by the number of shares you own in proportion to the number of outstanding shares. For example, if a company has 1,000 shares of stock outstanding and you own 100 shares, you will have a claim to 10% of the company's profits.
How are stocks created for trading in the public markets?
As a privately-owned company’s business expands, it may need to raise more money than what a bank can loan it to finance that growth.
One way to raise this money is if the company sells or issues its shares through a process called an initial public offering (IPO).
After an IPO, the company becomes publicly listed on a stock exchange, which makes its shares available for individual investors to buy and sell through brokerages, most of which are online these days.
Why should you invest in equities?
Data spanning numerous decades has shown that across different asset classes (such as stocks, bonds, and commodities), stocks have consistently posted superior returns.
As a shareholder of a company, your equity investment grows with the company’s profitability and the economy. Your return on investment comes from stock price appreciation and sometimes dividend income. This is why stocks are commonly used to build one’s long-term wealth.
Equities offer growth, but they also have a higher risk profile due to price volatility. Such risks can be mitigated by diversifying your investment across different asset classes, thereby locking in the higher returns from equities in the long term while smoothing out its associated volatility.
What makes a good stock investment?
A good stock investment should fulfil your financial goals at the risk tolerance you are able to accept, and generate positive returns.
One starting point is to decide what type of stock is suitable based on the life stage you are in.
If you are a young professional with a focus on wealth building, you might consider stocks that have the capacity for future growth but come with higher risk, such as small-cap and growth stocks. If you are a retiree with a focus on wealth preservation, you might consider stocks of established businesses that generate stable dividends and whose prices do not swing wildly, such as income and value stocks.
Historically, from 1926 till now, the average annual return on stocks has been about 10%. In some years, the stock market could generate higher returns than that; in other years the returns could be lower or even negative.
A reasonable expectation is to construct a portfolio of stocks that can return at around the 10% level over the long run.
Applying the principle of diversification is also important.
Spreading your investment across stocks from different geographies, sectors, and market capitalisations will lead to strong and stable returns.
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Next on the Endowus Fin.Lit Academy
Read the next article in the curriculum: How is a stock valued? Why are financial ratios important?
This article is for information purposes only and should not be considered as an offer, solicitation or advice for the purchase or sale of any investment products. It is recommended that you seek financial advice as to the suitability of any investment. Whilst Endow.us Pte. Ltd. (“Endowus”) has tried to provide accurate and timely information, there may be inadvertent delays, omissions, technical or factual inaccuracies or typographical errors.
Any opinion or estimate above is made on a general basis and none of Endowus, nor any of its affiliates, representatives or agents have given any consideration to nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Opinions expressed herein are subject to change without notice.
Investment involves risk. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Past performance is not an indicator nor a guarantee of future performance.
Please note that the above information does not purport to be all-inclusive or to contain all the information that you may need in order to make an informed decision. The information contained herein is not intended, and should not be construed, as legal, tax, regulatory, accounting or financial advice.