Investment Basics - Stocks
Companies that need to raise capital to finance their operations can issue stock. The first time a company issues stock to the public is called an initial public offering (IPO). Once a company issues an IPO, the stock can be traded on a stock market exchange. When an investor purchases a share of stock, the investor is buying an ownership interest in the company. Companies trade tens of millions of shares of stock each day on stock exchanges around the world. The two most commonly-used domestic exchanges are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ).
Types of Stocks
Companies may have different objectives when issuing stock. These objectives include whether a company wants to separate the shareholders’ financial interest in the company from the governance of the day-to-day operations, and whether the company issuing the stock wishes to have the stock traded on an exchange. Companies may issue common stock and preferred stock.
- Common Stock
Common stock is the type of stock issued most often by publicly-traded companies. Two reasons for investing in common stock are asset appreciation and dividends. Asset appreciation occurs when the value of a particular stock is greater than the amount an investor paid for the stock. Asset depreciation, which can also occur, occurs when the sales price of a stock is lower than the investor’s purchase price. Dividends are paid to shareholders from a company’s retained or current earnings. Common stock dividends are generally paid on a quarterly basis. Dividends are not guaranteed. When an investor purchases common stock shares in a company, the investor receives certain rights. For example, investors are able to vote in elections to pick a company’s leadership and on issues that are important to a company’s profitability and fiscal integrity.
- Preferred Stock
Dividends and safety are primary reasons for purchasing shares of preferred stock. Preferred stock does not offer investors the same level of capital appreciation as common stock does, but it also is not as volatile as common stock. Preferred stock shareholders may receive a consistent dividend payment. If a dividend is paid, the preferred stock dividend is paid first. In bankruptcy proceedings, preferred stock shareholders are paid before common stock shareholders.
Investors purchase stock through a broker. There are two common types of brokers: full-service brokers and discount brokers.
- Full-Service Brokers
Full-service brokers offer a wide variety of services and products. Many full-service brokers offer websites where clients can manage their accounts online, and also have branch offices so investors can meet locally with a financial advisor. Full-service brokers also usually offer financial planning services and give advice on selecting certain investments based on an investor’s goals and risk tolerance. Because of these services, full-service brokers are usually more expensive then discount brokers.
- Discount Brokers
Discount brokers generally are the least expensive way for investors to purchase stocks. Many discount brokers do not operate out of offices, and instead offer services online or by phone. Usually, when using a discount broker, investors will not receive financial planning services or investment selection advice. Investors that use discount brokers typically know what they want to invest in and are looking for the most cost-effective way to purchase those investments.
Diversification can help reduce risk and smooth large swings in a portfolio’s rate of return. Diversification applies not only to investing in different asset classes, but also should include diversification within asset classes. Investors can diversify a portfolio, for example, by choosing stocks in different sectors of the economy. If an investor doesn’t feel comfortable picking individual stocks for his or her portfolio, mutual funds and exchange-traded funds (ETF) can be purchased. Mutual funds and ETFs may hold a wide array of different stocks across a particular sector. These are some options to help diversify a portfolio of stocks and help limit risk in the portfolio.
Relief associations that are authorized to invest under the “expanded list” of investment securities may invest in domestic stock and foreign stock sold on an exchange in any country that is included in the Europe, Australia, and Far East Index (EAFE). (See Minn. Stat. § 356A.06, subd. 7(f) and (g).) Investments in stock from countries that are considered emerging markets and are not included in the EAFE are classified as “other investments.” The total of all “other investments” cannot exceed 20 percent of a relief association’s portfolio. In addition, the total of all domestic stock, developed-market foreign stock, and shares of stock authorized by the “other investments” section cannot exceed 85 percent of a relief association’s portfolio.
Published last in the May 2010 Pension Newsletter