A Guide to Stocks

There are as many different stocks as there are companies. Each type of stock has its own characteristics and can play its own role in a diversified investment portfolio. Some of the more common types of stocks are:

Growth stocks:

These are stocks of rapidly growing companies that invest most of their profits back into the company for continued growth. Investors are willing to pay a premium price for these stocks, because they believe the companies’ revenues and profits will continue to expand quickly, driving up the value of their shares. These stocks may be riskier than some other types of stocks, though, because most of the return comes from an increase in the share price. So if the growth slows, the share price might not continue to rise.

Large-cap, small-cap, mid-cap stocks:

This refers to the “market capitalization,” or the total value of all the outstanding stock issued by the company. Large-cap stocks are stocks of big companies, small-cap stocks are stocks of small companies, and mid-cap stocks are stocks of middle-size companies. In general, the smaller the capitalization, the riskier the stock. That’s because larger companies are more likely to be better-established and more secure in their industry.

Value stocks:

These are stocks that investors believe are a bargain. The companies issuing the stock usually are out of favor for some reason, so the stock price is relatively low. However, investors think the companies are still basically sound and may be poised for a turnaround, so they buy the stock in the expectation that it will begin to go up, thus increasing the value of their investment. These stocks are often less risky than growth stocks because they are less costly to begin with. However, if the company does not turn its fortunes around, the investment may not pay off.

You can buy stocks individually or as part of a fund that invests in a specific category or categories of stocks. For example, a fund might be a growth fund, a large-cap value fund, a small-cap growth fund, etc. The prospectus for the fund outlines the types of stocks the fund will own.

In addition to funds that offer a single type of stocks or a combination of types, there are funds that have specific investment approaches. For example:

Balanced funds:

These funds contain a combination of stocks and bonds. The objective of most balanced funds is to diversify risk and to generate a combination of growth and income. The percentage of the fund in stocks and in bonds – and how much the fund manager can adjust that percentage – differs from fund to fund. The risk also differs, depending on the makeup of the individual fund. As a general rule, the larger the percentage of stocks in the fund, the higher the risk.

Index funds:

An index fund is designed to mirror the performance of a specific stock index, such as the Standard & Poor’s 500 Index, which in turn is designed to reflect the return of all or part of the overall market. The stocks in these funds are chosen to replicate the index. These funds are not actively managed – that is, they don’t have a manager deciding what stocks to buy and sell. As a result, administrative fees for these passively managed funds tend to be lower than fees for actively managed funds. The riskiness of the fund is determined by the riskiness of the underlying index. A broad-based index fund like an S&P 500 fund is likely to carry less risk than a fund based on an index of small companies.

A well-constructed investment portfolio will likely include stocks from several of these categories, as you attempt to balance risk and return, and move toward realizing your financial goals.

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