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A stock is an investment vehicle that represents an equity or ownership interest in a company. For example, assume that a small privately held company has a total market value of $1 million. The owners of that company may choose to sell stock (representing a partial ownership in the company) to the general public. Assume that they offer to sell 1 million shares of stock at a price of one dollar per share (for a total of $1 million). If you, as an individual investor, invested $10,000 in this company you would be given stock certificates representing 10,000 shares of stock. Your 10,000 shares of stock represent 1% of the total stock of the company. If the value of the company goes up over time, the value of your 1% ownership interest also goes up at the same rate. A large company like Coca-Cola will have millions of shares of stock held by thousands of investors and representing billions of dollars in market value.

Stocks have historically outpaced other investment vehicles in terms of total return on investment. This has certainly been true over the past several decades. Historically, investors who have bought and held a diversified portfolio of stocks have enjoyed a steady increase in the value of their equity investments over time. As a general rule, returns on stock investments have outpaced inflation and generated a real increase in wealth for stockholders.

Over the past 50 years, the S&P 500 has averaged a 10% annual return - far more than an investor would have received by investing in CD's or other money market investments. The Dow Jones Industrial Average has returned an average of about 9% over the same period. What is more, in recent years, average returns have been increasing slightly - moving the average return ever higher.

Notwithstanding the recent correction in the market - precipitated primarily by the bursting of the internet bubble, the stock market appears poised to generate significant wealth for stockholders well into the future.

To the contrary. The stock market is an important investment vehicle for individuals of all incomes and circumstances. In fact, a solid investment strategy is probably more important to individuals with modest means than it is for people with great wealth. The compounded returns that have typically characterized the stock market will be vitally important to individuals who are counting on their investments to ensure a comfortable lifestyle into retirement.

Stock Price Appreciation

If you had been fortunate enough to invest $2,000 in the stock of Dell Computer at the beginning of 1990 and held it for ten years, the value of that initial $2,000 investment would have grown to well over a million dollars. Of course, most stock investments have not performed as well as Dell. But it provides a valuable insight into the potential for wealth accumulation through stock price appreciation.

Dividends

In addition to stock price appreciation, as a stockholder you will be entitled to a percentage of any profits that are distributed as dividends to company owners. Not all companies distribute dividends to shareholders, but many do. Dividends are generally paid quarterly. These dividend streams can be an important factor in the overall return on your initial stock investment. As a general rule, companies that are growing rapidly do not pay dividends. They use all of their profits to finance their growth. If a high growth company manages its growth wisely, the stock price appreciation that is achieved over time will generally more than make up for the lack of dividends.

When a company decides to sell it's stock to the general public it undertakes an initial public offering (IPO). To ensure a successful IPO, the company will typically retain the services of a good investment banking company like Merril Lynch or Goldman Sachs. The investment banker will identify potential investors and create an initial market for the stock. Once this initial stock offering is sold out, then in order to purchase shares of that company you must find an investor who already owns the stock and submit an offer to purchase some or all of his shares on the secondary market.

Thanks to the creation of stock exchanges, it is generally not difficult to find buyers and sellers of public stocks. A stock exchange is simply a collection of buyers and sellers of stock securities. Market prices are efficiently established through a continuous auction process that is governed by the laws of supply and demand. Order is maintained through a rigid set of rules, an impressive array of technology, and an organized hierarchy of intermediaries. A dedicated network of traders, brokers, and specialists ensures that buy and sell orders are executed in a timely and professional manner.

The New York Stock Exchange is one of the most famous and successful exchanges in the world. It is home to some of the largest and most respected companies in the world. If you wish to trade the stocks of these companies, you must ultimately do so on the floor of this venerable exchange. However, there are many other large and important exchanges - both in this country and in most other countries thoughout the world.

Historically, if a company's stock was not listed on one of the major exchanges, then it was typically traded in what is referred to as the "over-the-counter" (OTC) market. In recent years, the term "over-the-counter" has been largely replaced by the NASDAQ monikor. NASDAQ is the acronym for the National Association of Securities Dealers Automated Quotation system. The NASDAQ market is not housed in a central location like the New York Stock Exchange, rather it is a computerized network of traders and brokers spread throughout the country. Through the NASDAQ's sophisticated quote system, stocks are traded electronically in much the same manner as they are traded on the floors of the major exchanges.

As a small individual investor, you will not have access to the trading floors of the major exchanges. You must rely on a broker to execute your orders for you. Until very recently, most stock brokers had rigid requirements regarding the number of shares that could be purchased at one time and imposed minimum standards on the size of the accounts that they managed. They also charged high fees for their services. This created a significant barrier to investment for the small investor. With the advent of discount brokers, however, it has become much easier and cheaper for small investors to participate in the stock market. The internet has further shifted the balance of power in favor of the small investor. On-line brokers now account for an important and growing segment of the total market. Companies like E*trade, Ameritrade, Charles Schwab, TD Waterhouse, and a host of others, have done a remarkable job of leveling the playing field for the small investor. It is relatively easy to set up an on-line account with one of these companies.

Most of the on-line services will allow you to open an account with a $500 balance - and sometimes less. Many will even offer you a number of free trades to help you get started.

Fees vary considerably. Most disount brokers charge between $10 and $25 to execute a trade. However, some are currently advertising rates as low as $8 per trade. You will pay this fee when you buy the stock and again when you sell the stock. You need to factor these brokerage commissions into your thinking as you evaluate the potential for generating a profit through the buying and selling of stocks.

If you trade through discount brokers you will generally not receive advice on investments. Full service brokers such as Merril Lynch will assign you to a broker who will dispense advice. The fees for these full service brokers are dramatically higher than those charged by their discount counterparts. Many investors believe that they are better off doing their own research on potential stock investments and saving themselves a lot of money in commissions.

Most of the discount brokerage companies have very reliable trading systems and provide excellent customer service free of charge. With a little homework you will be able to select an on-line service that fits your needs.

Understanding Investment Risk

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