Stocks: Disadvantages of
owning a stock
Stocks are volatile. A single stock's share
price can vary widely from day to day, month to month, and year to year
depending on numerous factors that are beyond your control. The most
effective way to invest in stocks is to "buy and hold" for the long-term and
"diversify" (divide your stock holdings among several different stocks in
various market sectors).
Companies can and do go out of business, at
which time their stock usually becomes worthless. But if you select your
stocks carefully you can greatly minimize this risk. Both buying and selling
stocks cost you money in the form of brokerage commissions, so the best
strategy for investing in stocks is for the long-term.
- Significant time to
research and track a stock - Even though
you don't have to think about running a company, you do have to know
quite a bit about the company you're investing in. You need to take the
time to research about the company and ask questions like "what products
does it sell and who are the customers?", "what much debt does the company
have and will it be able to pay it?", "what are its prospects for future
growth and profitability?", etc. You need to monitor your investment after
you have acquired stock in the company as long as you hold that stock. You
also must make decisions to sell a stock without emotions because when
your money is on the line, emotions undermine your ability to make sound
long-term decisions. If you don't have the time nor knowledge to pick
stocks, you might want to consider investing in stocks mutual funds
managed by expert portfolio managers (see our
mutual funds section).
-
You may lose your investment - By becoming a shareholder in a company , you assume the risk of the
company not being successful. Just as a small business owner isn't
guaranteed a return, neither is a shareholder.
It must be emphasized that there are no guarantees when it comes to
individual stocks. Some companies pay out dividends, but many others do not.
And there is no obligation to pay out dividends even for those firms that
have traditionally given them. Without dividends an investor can make money
on a stock only through its appreciation in the open market. On the
downside, any stock may go bankrupt, in which case your investment is worth
nothing.
- Less claim on assets than
creditors - If you own shares in the company that goes bankrupt and
liquidates, you don't get any money until the banks and bondholders have been
paid out. Shareholders are the last people to get paid. You can earn a lot if
a company is successful, but you can also stand to lose your entire investment
if the company isn't successful. Although you do take the risk of losing
money, there is also a bright side. Taking-on greater risk means a greater
return on your investment. This is the reason why stocks have historically
outperformed other investments such as bonds or savings accounts. Over the
past two centuries, an investment in stocks has historically had an average
return of around 11 percent.
The closer you get to retirement age, the
more risks you assume with stocks, therefore stocks are best used in the
early and middle stages of your career. Since stocks are so volatile
short-term, as you begin to reach retirement age, you should start gradually
moving part of your assets into other sectors.
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Why
does a company issue stock?
Why would the founders
share the profits with thousands of people when they could keep
profits to themselves? The reason is that at some point every
company needs to raise money. To do this, companies can either
borrow it from somebody or raise it by selling part of the
company, which is known as issuing stock. A company can borrow by
taking a loan from a bank or by issuing bonds. Both methods fit
under the umbrella of "debt financing."
On the other hand,
issuing stock is called "equity financing." Issuing stock is
advantageous for the company because it does not require the
company to pay back the money or make interest payments along the
way. All that the shareholders get in return for their money is
the hope that the shares will some day be worth more. The first
sale of a stock, which is issued by the private company itself, is
called the initial public offering (IPO). If you want to know more
about how stocks are created, check out our IPO tutorial. |
Next-->>
Different kinds of Stock
To be a champ
you
have to believe in yourself when nobody else will.
-- Sugar Ray
Robinson --
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