Stock

A stock is a type of security that represents ownership in a corporation. When individuals purchase stocks, they effectively become part-owners of the company. This ownership provides shareholders with a claim on a portion of the company’s assets and earnings, which is proportional to the number of shares they hold. Stocks are a key component of many investment strategies, including those used in retirement plans, as they offer the potential for significant growth over time.

How stocks work

When an individual buys stock, they purchase shares representing partial ownership in the issuing company. As part owners, shareholders may benefit in two primary ways: dividends and stock price appreciation. Dividends are distributions of a company’s profits to shareholders, typically paid out quarterly. Stock price appreciation occurs when the value of a stock increases over time, allowing investors to sell their shares at a higher price than what they originally paid.

Types of stocks

There are two main types of stocks: common stock and preferred stock. Each offers different rights and benefits to shareholders.

Common stock

Common stockholders have voting rights, typically allowing them to vote on important corporate matters, such as electing board members. In addition to voting rights, common shareholders may receive dividends, which are not guaranteed. The value of common stock can fluctuate widely based on the company’s performance and market conditions, making it a potentially lucrative but riskier investment.

Preferred stock

Preferred stockholders, on the other hand, do not usually have voting rights, but they are given priority when receiving dividends. In the event of a company's liquidation, preferred shareholders are also paid out before common shareholders. While preferred stocks are generally less volatile than common stocks, they also offer less potential for price appreciation.

Mutual funds or target-date funds, popular investment options in 401(k) plans, can include both common and preferred stocks. These funds often provide diversification by pooling together a variety of stocks, reducing the risk associated with investing in individual companies.

Stocks in retirement plans

Stocks are critical in a diversified retirement portfolio, primarily because they may offer growth potential through capital appreciation. Over time, stocks can help investors accumulate wealth, especially when part of a long-term investment strategy. In retirement plans like 401(k)s, stock-based investments are often included through mutual funds which track the performance of a market index. and help investors capture the overall growth of the stock market while benefiting from professional management and diversification.

However, it’s important to understand that stocks are generally more volatile than other asset classes, such as bonds. This means they can experience significant price fluctuations in the short term. Despite this volatility, stocks have historically provided higher long-term returns than bonds, making them essential for investors aiming to grow their retirement savings over several decades.