Getting your slice of the growing corporate pie

When you buy a common stock, you are actually investing in a company with the expectation of sharing in their future earnings. You become an owner along with thousands of other people who have entrusted their hard-earned money to the company's management in hopes they are able to grow it into many times your original investment.

When investing in individual stocks, you will want to spread your funds over a number of companies, diversifying your portfolio. However, to do that you'll need a reasonable sum of money. By purchasing a larger number of shares you'll reduce commissions, making it more cost effective. There are a number of discount brokers you can use for buying and selling stocks, or you can have your investment advisor do it for you.

In addition to common stock, companies issue what are called preferred shares that entitle investors to a fixed dividend paid before common stockholders receive anything. It's often considered a hybrid between bonds and common stock. They're not nearly as prevalent as common shares but still can occupy an important part of your portfolio. It's really a matter of how much interest income you desire as opposed to capital gains.

Many newcomers to the stock market are attracted to penny stocks because they are cheap, and so they seem low-risk. Penny stocks generally refer to any stocks that sell for under $1.00 per share, although some people use the term to describe shares that are worth less than $5.00. However, shares this cheap tend to be offered by very small companies and they are usually very high risk. Upstart companies are prone to failure, and while you stand to make a fortune if the company succeeds, you are much more likely to lose your investment. Furthermore, since these stocks are usually traded over the counter, rather than through a stock exchange, there is very little regulation and a high risk of fraud. Buyer beware!

Many investors purchase mutual funds and exchange-traded funds instead of individual stocks. They've decided investing in these products gives them the diversification and professional investment management they're most comfortable with. A product that has gained popularity in recent years is the Separately Managed Accounts (SMAs). These combine professional investment management with ownership of the individual stocks in the portfolio, as opposed to mutual funds that share ownership with other investors. Generally regarded as a product for the wealthy, SMAs have become the fastest-growing segment in the investment management industry.

Ultimately, the best reason to invest in stocks is that historical returns compared to bonds and certificates of deposit are significantly higher. The S&P 500 has an annual return of 10.2 percent compared to 5.4 percent for intermediate-term bonds and 3.8 percent for cash (represented in this example by treasury bills). With stocks almost doubling the returns of bonds, it makes sense for all but the most senior investor to be invested in them.

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