Investing in stocks is a great way to improve your portfolio and increase your passive income. This means your finances will look better on paper, helping you secure loans and mortgages. You can also earn some pocket money without too much effort.
However, understanding how stocks work and what each stock type means, is an important step to avoiding mistakes. Stocks don’t always produce positive results, so you need to be aware of the consequences before you invest.
Today we will explain how to get started, the different types of stocks, and offer you some helpful tips to keep your investments positive.
Table of Contents
Before we start learning about the different types of stocks we need to explain the basics.
What Are Stocks?
Companies sell stocks to help raise money for their business. The money could do anything from covering losses or expanding the business.
To make a profit in stocks you need to invest in a company that has growth potential. For example, your initial investment could be worth $100, however as the company expands each share might grow to $250. In this scenario, you would have earned an extra $150.
However, if the company loses wealth, your stock could shrink in worth too. Your $100 investment might reduce to $50.
These are simply examples of what could happen to your investment.
When you invest in stocks, you are buying shares of a company. A company will have one stock value but multiple shares. As we said before, when you invest in stocks, you are hoping that the company chosen will grow in value. As this happens more people will invest and your shares will become more valuable as an outcome.
When their value increases, other investors will want to join in on the potential profit. This will allow you to sell your shares for a higher value, creating your own profit.
When you are first starting, it is important to begin your journey with low-value investments and reliable stock.
Putting a lot of money into a risky investment such as a new business could give you a massive profit. However, you could lose your high-value investment too. As you get used to the investment environment, you should start off with something safe, and stick to low-value investments.
Open An Investment Account
To invest in the stock market, you need to have an investment account also known as investment vehicles. There are normally two options that people go for, a brokerage account or a robo-advisor account.
A brokerage investment vehicle tends to be the fastest and cheapest path to investing. This is because traditional IRAs or Investment Retirement Accounts are tax-exempt until you try to withdraw the funds.
This allows you to grow capital a lot faster than other standard accounts. However you can opt for a Roth IRA , it will tax you when you put the money into the account, but doesn’t tax you when you withdraw. This creates a smaller growth, but also a smaller tax fee.
Robo-advisor investment vehicles, however, are easier to run, as the automated system finds the best investment options for you. They do all the research and place your finances into stocks on your behalf using Personal Finance Software.
They also take the funds away when the shares start to decrease in value. With robo-advisors you don’t need to do as much work. However, these features come at a higher cost.
Understand Different Stock Market Sectors
When you first look at the lists of stock available, you will notice that they are broken into sectors. If you already have knowledge in one of these sectors, then you will have an advantage over other investors. Your knowledge could help you find solid investments and avoid questionable businesses.
The different sectors include:
- Communication Services
- These include entertainment companies, general media, telephone companies, and internet companies.
- Consumer Discretionary
- These include automakers (like car manufacturers), the hotel industry, restaurant companies, and general retailers.
- Consumer Staples
- These include perishable goods such as beverages, food, and tobacco.
- These include fossil fuels such as gas and oil, but also sustainable fuels such as solar and wind companies too.
- This sector includes any financial industry from brokers to bankers, mortgage advisors to insurance companies.
- You can find crossover companies in this sector, for example, health insurers can be found in the financial sector and in the healthcare sector. There are other businesses too such as drug companies, hospitals, and biotech companies.
- This sector includes construction and mass market-based companies such as airlines, machinery, and railroads companies.
- This sector includes companies that deal with raw materials such as woodcutting, mining, and creating chemicals.
- Real Estate
- Real Estate is another sector with some crossover. You can find people selling property, and mortgage managing bankers.
- This sector includes both software and hardware equipment as well as IT services
Unlike the energy sector, utility companies deal with the distribution of energy, not the collecting of it.
Learn The Different Ways To Invest
We have already talked about robo-advisors and brokerage accounts, but there are other options available to you too. The next most popular investment methods are individual stocks and index funds.
Investing in individual stocks is a great way to receive big profits, but they take a long time to grow and they take a lot of research to get right. We would only recommend this investment method if you already have experience in the stock market.
Index funds pair well with individual stocks. They don’t cost as much money and they can almost guarantee you a long-performing passive income. It works by mimicking the stock market matching high performances without needing to be managed.
Mutual Funds allow you to invest in stocks by using a pool of money. The pool will consist of individual investors chipping together to purchase an expensive investment. This allows you to diversify your investment portfolios without as much risk.
ETFs are like mutual funds, as a pool of investors come together to purchase stock. However, unlike mutual funds, they can be sold through the stock market.
Different Types Of Stocks
Now to dive into the different types of stocks you can choose. Each has its own perks and drawbacks, so pick something that best suits your investing goals.
The most popular type of stock is the common stock. This investment type represents partial ownership of a company. If the company you are investing in dissolves, you will have the right to receive a share of the remaining assets after the creditors.
The common stocks can have unlimited gains from an investment, but they risk massive losses too.
Preferred shareholders don’t receive any money should the company dissolve, however they receive a dividend payment for their shares. As the name suggests, these shareholders are preferred over the common stocks and generate constant passive income for their investors. However, they don’t have a say in the company, as the common shareholders do.
These two are the most common types of stocks. If you are choosing between the two, you are really choosing power in the company or passive income.
Large-Cap Stocks, Mid-Cap Stocks, Small-Cap Stocks
Another way to categorize stocks is through their size or worth. The term for this is Market Capitalization. If the company you are investing in is large, then they will have large-cap stocks. Small and local companies often have small-cap stocks.
“Cap” in this instance doesn’t refer to a barrier, but instead it refers to the capital in the business. There isn’t a precise definition for each group however you can expect large-cap businesses to have capital of $10 billion or more, whereas smaller companies don’t tend to reach over $2 billion.
The safest businesses to invest in are large-cap companies. This is because they have a lot of capital to lose before putting your investment at risk. However small-cap companies can give you the biggest profits due to their low prices. If they start to gain value, your small investment can grow quickly. But their low capital means you are risking a big loss too.
Domestic Stocks Vs International Stocks
When you are expanding your investment, it is good to diversify your passive income in case one sector begins to fall. One way to do this is by mixing domestic and international stocks.
Domestic stocks are defined as stocks for companies whose headquarters are in the same country as you. International stocks are for companies whose headquarters are in a different country to you.
There isn’t much to differentiate the two stock types when it comes to investment. However, you may find that some countries are performing better than others within certain sectors. If that country’s currency or financial situation falls, your diversification can support the failing investment until you find stability again, thereby reducing your losses.
Value Stocks Vs Growth Stocks
The next way to categorize stocks is through their values and growth.
Value investments are when you put money into a well-established company that probably won’t grow much more but will give you reliable returns. Don’t get these confused with large-cap stocks. The difference is through constancy and reliability over actual value.
For example, a long-running shop in a small local town, which has lots of traffic and a sound business plan could offer value stocks. Their reliability and strong stability would make them reliable, and their lack of desire to expand keeps them consistent.
Growth stocks, however, have higher risks and high rewards. These businesses are planning to grow in some way or another. This means they need your investment to allow this growth to happen, but the change might not be successful.
Competition in every industry is fierce, and even big businesses can fail and lose money on their growth. However, if the company’s plan succeeds, you could be in for a massive profit due to investing at an early stage.
Initial Public Offering Stocks
Also known as IPO stocks, Initial Public Offerings are a type of investment offered by private companies which have recently turned public. To get investments from multiple people on the stock market, a business has to be a public company.
Businesses that are already successful, but hope to expand, often use IPOs. These allow them to jump straight into the high-ranking stocks while still feeling new.
Because this type of stock includes experienced businesses such as Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL), you can buy the stock with the security of knowing they are safe. These stocks will only be labeled as IPOs for a year but in that time their prices will be cheaper while still being reliable.
Dividend Stocks Vs Non-Dividend Stocks
You might wonder what the point of a non-dividend stock might be. If you aren’t getting a passive income from your stocks, then what are they good for? Non-dividend stocks are not designed to give you constant financial returns. Instead, you should think of them as real estate investing or art investing.
When you buy a house or artwork, you don’t make the purchase expecting money to drip from the edges. Instead, you hold on to these valuable items, and then after a couple of years or even decades, you sell the items on.
During this time the item should have increased in value. When you sell it, you should use a higher price tag than what you originally paid for it. This is how you make money on a non-dividend stock.
These returns tend to be bigger than dividend stocks, however, it all relies on you selling the stock before they lose value. The risk can be large.
On the other hand, dividend stocks give you monthly payments for your investment. They are a constant form of passive income even if the value is low. For example, some dividends will only pay $0.01 a month. Although this return is shockingly low, it still counts as a dividend payment.
If you are hoping for a little extra cash in your pockets, you should aim for dividend stocks. If you want to invest in something that might give you great returns all in one go, then go for non-dividend stocks.
Income stocks are a type of dividend stock. They offer regular payments and usually these payments steadily increase the longer you keep them. You can also expect income stocks to have a low-risk factor and low volatility. The income won’t be large, however, it will be steady.
A lot of investors opt for income stocks to boost their portfolio with corporate profit. They are reliable stock options that very rarely fail. The best income stocks will have a treasury note that increases dividends to keep up with inflation. This will allow the value of the stocks to remain the same, despite the changes in the financial market.
Cyclical Stocks Vs Non-Cyclical Stocks
Cyclical stocks are investments with prices that change. Following the economy, these stocks go in cycles of increases and decreases. If the country starts going through a recession, so do the stocks. But if the economy goes through a boom, your figures will increase too.
As you can expect, non-cyclical stocks don’t follow this pattern. They don’t profit or degrade due to the changes in economic trends. This means they are more reliable and are great choices for investors looking for stable dividends.
Without a doubt, non-cyclical stocks will outperform cyclical stocks during a slow growth term in the stock market, but cyclical stocks can create massive booms during unexpected highs.
Examples of cyclical stocks include companies that sell items, restaurants, hotels, airlines, and manufacturers. This is because their services are not essential, and their price or worth changes with the economy.
Examples of non-cyclical stocks include grocery stores, food suppliers, utility suppliers, healthcare providers, and stable goods such as toilet paper and toothpaste. These businesses are considered essential even in times of crisis, which means you won’t expect them to change even when the economy falls on hard times.
There are exceptions to these rules, which are often determined not by demand, but by supply. For example, fuel is often considered a non-cyclical stock. A lot of the world’s fuel comes from Russia’s oil. With Russia at war, the world’s oil economy has sky-rocketed creating an unexpected change from non-cyclical stock to cyclical stock in this sector.
Safe stocks are another type of low volatility stock, making them relatively safe in the investment world. Their prices very rarely change and when they do, it’s just in small increments of ups or downs. They tend to be dividend stocks and not non-dividend due to the lack of change. They will likely be connected to non-cyclical stocks too.
Safe stocks are named this for a reason and are a great choice for people needing a stable investment or who are just starting out.
Popular safe stocks include The Walt Disney Company (NYSE:DIS), Starbucks (NASDAQ:SBUX), and Apple (NASDAQ:AAPL).
The Philosophy Of ESG
ESG stands for Environmental, Social, and Governance. It’s an investing philosophy that priorities financial returns that don’t negatively affect or impact the environment or world around us.
Investing in a business that follows governance, creates positive social impact, and respects and cares for the environment allows for responsible growth within our society. It is one way in which you can help the world without changing your life.
When you decide to invest in a company, see how they address environmental issues – do they use renewable energy, what is their carbon offset, do they promote employee carbon offsetting through public transport, etc.
Next check their social responsibilities. How low is their employees turnover, is their supply chain ethical, what are their views on social justice issues, etc.
Lastly, as part of the governance section of ESG, consider how diverse the company is, how transparent they are towards their shareholders, and their history of lawsuits.
Understanding these aspects of a business can help you decide if they follow the same ethical pursuits as you. Without searching for ESG you could be investing in a company you disagree with.
Now that you know what type of stock you want to invest in, we want to give you some helpful tips to avoid losing money.
Create A Goal For Yourself
You should create a goal that is more detailed than simply making money. Instead, decide what this money is going to be used for. Understanding this aspect of your goals can help you decide the best stocks to invest in.
For example, if you want to invest in stocks simply because it seems interesting and you want to dabble in something new, use online brokerage accounts. You need to do the research to get good results, but you will learn a lot more about the market this way.
If you have a goal of a certain amount, you should use a robo-adviser. You can tell the advisor what your amount is and the timescale you want to achieve it by. They can then find the best stocks for this goal and show you the risks along the way.
Lastly, if you simply want to save as much money as possible for retirement, then you should invest in an IRA. You cannot take the money out until you retire, but being locked into the investment account means it will grow very large.
Always Have An Emergency Fund On Hand
Unfortunately, investing doesn’t always produce income. Sometimes you will lose money. Because of this, you shouldn’t invest more money than you are prepared to lose. Before you start investing, you should have an emergency fund of 3 months’ pay stored away in a savings account.
Having an emergency fund is good advice for any financial situation, but for investing in general, you cannot put all of your money at risk. Even low-level risks still have the potential to fail, leading to financial instability and losses.
Compare Your Costs And Features Regularly
Although systems like robo-advisors allow you to invest without doing research or spending a lot of time monitoring your finances, you shouldn’t allow this freedom to go unchecked. Instead, you should go through your costs and change your features every week at least. This will allow you to pull out of a bad investment before you lose your money.
Diversify Your Portfolio
We have talked about the importance of diversification already. Earlier we discussed domestic and international stocks, but it is important to branch away from stocks too. You may want to invest in Crypto NFTs, real estate, or government bonds.
Putting your money into different pockets will allow you to capitalize on surprise growth and protect against unexpected declines. If your money is in one place a shocking decline could ruin your hard work.
The best way to diversify your portfolio is to invest in alternative investments. They include anything other than stocks, bonds or cash. As discussed earlier, art investment or art equity will allow you to invest in something beautiful, hold on to the value object and watch it’s worth grow. You can then sell the item for a greater price. Similar alternatives offer the same strategy, like private equity, land, venture capital, even commodities such as gold and silver.
If you would rather invest in something that can give you dividends or monthly returns, then you may wish to try income producing properties such as rentable real estate. Choosing mixed use property financing or crowdfunding real estate allows for more collaborative investing, whereas short term investments with higher interest rates.
Invest Only In Businesses You Understand
Unless you have experience with stocks already, you should start your journey into investing through the information you are already familiar with.
For example, if you work in the restaurant industry you will know how important foot traffic is, how significant returning customers are and how damaging competition can be. Knowing this you can figure out how successful a start-up restaurant might be.
Putting your knowledge into investing, you can scout out the potential investment opportunities in a new restaurant and weigh up the risks in funding the start-up.
The more specialized you can be, the more information you will have to help you find secure investments in that area. After a while and through active experience in the stock market, you will become knowledgeable about stocks too. When you feel confident in how the stock market works you can branch out and diversify your portfolio as we have discussed.
Avoid High-Volatility Stocks
Although highly volatile stocks can seem attractive, they come with a lot of risks. New investors should avoid these investment types until they are familiar with the stock market and the way in which it can dramatically change.
Understanding which stocks are highly volatile will be easy, as you will be given warnings about risks before you accept or finalize your investment. If you are unsure, talk to an advisor to help you understand any jargon that might come your way.
For this first part of your journey, stick with low-risk investments.
Avoid Penny Stocks
Penny stocks haven’t been mentioned yet in this article, but they are important to note. They refer to stocks of small companies that tend to sell their shares for low prices. Often $5 or less.
The low price line is meant to interest beginning investors due to their low cost. However, companies often create penny stocks due to a lack of liquidity. This means that they don’t have enough accessible money to pay for either basic company needs or expansion concepts. Due to this lack of funds, they are asking for a small amount from investors.
This should be producing red flags in your mind. Just as people should have an emergency fund, so should businesses. The pandemic alone showed the world just how quickly and long-lasting an unexpected issue can affect our finances.
If a company is creating penny stocks, they are showing everyone that they don’t have enough money. Therefore you will be likely to lose your investment too. This is a high-risk low-reward investment.
Learn The Basic Metrics
The 4 basic metrics that you should be aware of are the price to earnings ratio, the price to book ratio, the debt to equity ratio, and free cash flow.
We will explain them briefly here.
Price to earnings ratio (P/E) is a comparison between the price of the stock and the company’s earnings. It tells you if the stock is over or undervalued. You can use this figure to see how the competitors’ stocks compare.
Price to book ratios (P/B) also shows you if the stock is over or undervalued. It does this by dividing the stock’s share price by its equity or book value per share. Seeing how much equity the company has tells you how much they are willing to pay for the company’s net value.
The debt to equity ratio (D/E) shows you how well the company is dealing with its assets. A low debt and high equity ratio shows that the company isn’t using the shareholder’s investment to pay off debts. High debt suggests that the company needs your finances to stay afloat. If you see this, don’t invest with them.
Free cash flow is how much money the company has after they have paid bills and employees. If you see an increase in free cash flow, you can expect a higher payment later.
Always Evaluate Stocks
Using the metric information above, while understanding your own goals and realistic expectations, you can evaluate your options before investing. All of the information we have given you can be used to find viable options to invest your money in safely.
Your evaluation isn’t just for the initial investment either. You should be checking in on your stocks and confirming if they are still a good investment or if their risk levels have increased.
Find the balance and stay vigilant.
Know The Risks
Before you invest in any stock be sure that you are aware of the risks. No matter how secure an investment might seem, there will still be a likelihood of failure. No investment is 100% safe.
This is why we suggest investing in low-risk stocks with money you can afford to lose. That way the risk of losing the money is low, and if it does happen you won’t be in a terrible financial state.
When you receive your dividends, you need to consider how to use them. A safe way to continue growing your funds is to split a portion of gains between re-investing and saving.
This way, your only true risk of loss comes from your initial investment, all subsequent investments are based on profits.
However, if you are saving for retirement or any other goal, you need to put these funds into a savings account.
Understanding the different ways in which stocks can increase your wealth and portfolio is just one area to keep in mind when you start investing. You also need to consider diversification, your own investing limits, the metrics of the companies you want to invest in, and the ESG philosophy.
The most important aspect to remember is risk. Only invest what you are willing to lose, and pick low-risk stock options to decrease that likelihood.
Paul Martinez is the founder of BendingDestiny.com. He is an expert in the areas of finance, real estate, and eCommerce.
Join him on BendingDestiny.com to learn how to improve your financial life and excel in these areas. Before starting this blog, Paul built from scratch and managed two multi-million dollar companies. One in the real estate sector and one in the eCommerce sector.