Analyzing The Best Retirement Plans And Investment Options: Stocks
- What they are: Securities that represent ownership in the corporation that issued the stock. Stocks are also called equities.
- Pros: Capital appreciation; often outperform other investments; dividend payments; diversity; voting rights.
- Cons: Prices can fluctuate dramatically (volatility); potential to lose entire investment.
- How to invest: You can trade online using your broker’s online trading platform, or by calling your broker’s trade desk to place orders. You can also buy stocks through a dividend reinvestment plan (DRIP).
Stocks represent partial ownership in a corporation. When you purchase a share of stock, or shares or stock, you are essentially buying a piece of the company, albeit a little one. Most individual investors will never own enough stock in a single company to represent a significant ownership stake (to illustrate: Warren Buffett, who will own about 9 million Goldman Sachs (NYSE: GS) shares by October of 2013, will have a stake of about 2%).
Investors purchase stocks for a variety of reasons, including:
- Growth potential
- Liquidity (you can close a position if you need cash quickly)
- Dividend payments (that provide income or that can be reinvested to purchase additional shares)
- Stocks have consistently outperformed other investments
While stocks can be traded actively (scalp traders, for example, get in and out of trades in a matter of seconds), a buy and hold strategy is popular for many investors. With a buy and hold strategy, investors seek gains over the long-term, riding out any fluctuations in the market.
If you own stock, you can make money when it appreciates in value and you sell it, and/or through dividend payments.
Types of Stocks
There are a number of ways that stocks can be categorized. One method is the size of the company - known as its market capitalization or, simply, market cap. A corporation’s market cap is the total dollar market value of all its outstanding shares, calculated by multiplying its shares outstanding by the current market price of one share. For example, if a company has 1 million shares outstanding, and the current market share price is $50, the company’s market cap would be $50 million (1,000,000 * $50 per share). While there is no universal "cut off" for different caps, the approximate categories are:
- Mega cap: $200 billion +
- Large cap: $10 billion to $200 billion
- Mid cap: $2 billion to $10 billion
- Small cap: $300 million to $2 billion
- Micro cap: $50 million to $300 million
- Nano cap: less than $50 million
- Growth stocks - these stocks have earnings that grow at a faster rate than the market average. Investors typically seek capital appreciation since growth stocks rarely pay dividends.
- Income stocks - these stocks pay consistent dividends, providing an income for its investors.
- Value stocks - these stocks have a low price-to-earnings (PE) ratio. Investors purchase value stocks in the hopes that the stock’s price will rebound.
- Blue-chip stocks - these stocks are from large, well-known and well-established companies with solid growth histories. Blue-chips usually pay dividends.
There are two ways that you might owe taxes on your stock investment. One is if your stock pays a dividend. If so, they are generally taxed at a rate of up to 15% at the end of each year, even if you never received the cash dividend (e.g. the dividends were automatically reinvested through a DRIP). In addition, if you sell the stock you will have to pay a capital gains tax if you held the stock for more than one year (long-term capital gains), or the gains will be taxed as ordinary income if you held it for less than a year (short-term capital gains). Analyzing The Best Retirement Plans And Investment Options: Conclusion