Stocks: Getting to Know Them

After Anna received half of a joint stock brokerage account in her divorce, she went to see Sam, a stockbroker recommended by a family friend. Sam quickly found that Anna’s knowledge of investments was slim, so he explained stocks to her.

Stocks in a company represent a portion of ownership, called shares, that are bought and sold through an exchange.

The three biggest exchanges are the New York Stock Exchange (NYSE), American Stock Exchange (ASE), and National Association Securities Dealers Automatic Quotations (NASDAQ), sometimes referred to as “over the counter”.

There are two main types of stock: common and preferred. Both represent ownership in a company, but common stock holders have company voting rights and common stock may pay dividends. Preferred stock has no voting rights, but pays regular dividends at a pre-set rate that does not vary with stock price or company performance.

Sam explained more of the stock-market jargon. Growth stocks are in companies whose stock price appreciates with time. Value stocks are in companies whose stock price is abnormally low, but the fundamentals of the company are good.

Growth and value stocks may or may not pay dividends. Income stocks pay higher dividends, so the stock price is not so volatile. In addition, all of these stocks are categorized based on capitalization (share price multiplied by the number of shares outstanding): large cap, medium cap, and small cap.

Historically, small cap stocks outperform large cap, but in declining markets investors turn to well-established “blue chip” large cap companies for stability. Anna was overwhelmed by all this information, but Sam assured her that over time she would become comfortable with the terminology and concepts.

Anna’s primary goals are saving for retirement and college education for her children. Sam explained that the speculative stocks in the brokerage account were not suitable for Anna’s goals.

Since Anna can contribute 16% of pre-tax earnings to her company’s 401(k) plan, he told her it was an excellent way to save for retirement. Because Anna was years away from retirement, Sam suggested growth investments in the 401(k).

For the college account, he recommended diversifying in mainly growth and value stocks, and some mutual funds, one of the best ways to spread risk for the highest level of return. Anna felt confident in Sam’s advice and asked him to build her portfolio as he suggested.

Mary, a recent widow, sought the advice of Harriet, a financial planner. She had received the proceeds of a life insurance policy on her husband’s life, and she wanted to use this for her retirement.

Mary also needed current income, as her new job barely covered her living expenses.

Harriet recommended allocating the money between mutual funds and bonds for her retirement account. She also suggested buying some income stocks to augment her salary.

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