Understanding Stock Market Investing: Benefits and Advantages

Why do so many investors choose to risk their money in the stock market? There are many other investment vehicles out there, including real estate, precious metals, rare artwork and the like, all vying for every investment dollar. Yet investing in stocks offers a number of advantages. Among them are the relatively low commission costs, the ease with which they can be safeguarded, the transparency of the market (meaning that market prices can quickly and readily be determined), the speed at which securities can be bought and sold, and most certainly, their track record. Over the long term, investing in stocks has proven to be an excellent way to outpace inflation. Additionally, stocks can pay in two different ways.

Many common stocks and all preferred stocks pay dividends. Most declare the dividend to be paid annually but actually make their distributions on a quarterly basis. The amount and timing of dividend payments are at the discretion of the corporation's board of directors. Most profitable corporations share their profits with their investors by paying them a cash dividend. However, there is no law that states that a company must pay a dividend on its common shares, even if the company is profitable. Dividends on common stock are flexible, but companies generally attempt to maintain a fairly even flow of them, increasing the dividends when the company enjoys a growth in net earnings and reducing them in leaner times.

Stocks that pay out a fairly generous dividend are known as income stocks. These are generally popular with individuals or institutions that are satisfied with the stock's rate of return in and of itself, particularly if it exceeds the return currently offered by savings accounts or certificates of deposit. Yet, while the receipt of income is important to many investors and is sometimes the only reason for purchasing a stock, others hope to acquire an additional return in the form of capital gains.

When a stock is purchased at a given price and subsequently sold at a higher price, the resulting profit is known as a capital gain. The stocks of companies that are expected to grow over time are known as growth stocks. Many growth stocks pay out very little in dividends or none at all. Investors often buy such stocks with the anticipation that their per-share value will increase over time as the company prospers. When stocks that have been held for more than a year are sold at profit, the profit is known as a long-term capital gain. Profits realized from the sale of securities that were held for one year or less time are called short-term capital gains. A capital gain will also result from a short sale that occurs when a security is first sold and subsequently purchased (or covered) at a lower price.

While certain stocks are definite dividend-payers with little chance for growth in share price (known as cash cows), and others offer small dividend potential but a good chance for capital gains (the stocks of venture capital or start-up companies, for example), many stocks—perhaps even most—offer possible profits through a combination of both dividends and capital gains. Most well-rounded portfolios have a balance between income producers and stocks with capital gains potential. Ultimately, that's why stocks are purchased: for solid returns through sound investment.