Why Do People Buy Stocks?

November 9, 2021
financial literacy

Investing can be one of the best ways to use your money. Through investments, you can have your money earn you even more money.

One of the most common types of assets people buy — and one you likely hear about all the time in the news — is stock. Maybe you have a vague understanding of what stocks are, but why do people buy them? And what benefits do they provide to an investor?

In this article, we’ll explain what stocks are and talk a bit about some different types. Then, we’ll show you the benefits of buying stocks to invest in yourself and the children in your life.

What Are Stocks?

Stocks are a type of security — a tradable financial instrument. They represent a portion of ownership in a publicly-traded company. They’re also called equities.

You must be at least 18 to buy stocks, although some states require you to be 21. That said, you can own stocks under age 18 or 21 with special types of accounts called custodial accounts.

Companies often issue stock to raise money to fund projects, such as launching new products or expanding into new markets. To do so, they go through an Initial Public Offering process, where their stock is first made available to the public.

The stocks are then traded on stock exchanges, like the New York Stock Exchange.

When you buy a share of stock, you are essentially buying a slice of that company. Then, you share in company profits and losses.

For example, if you buy five shares of Apple, you are now part-owner of Apple. 

Most stock investors own common stock, and the word “stock” itself usually references common stock. The other broad type is called preferred stock, but they work differently.

For the purpose of this article, we’re going to focus on common stock.

Stockholders typically get to vote in company shareholder meetings and have other rights, but the primary purpose of buying stocks is to build wealth and make money. 

This is possible in two ways:

  1. Stock prices can go up, and you can sell your shares for more than you bought them for, creating a profit (called a capital gain).
  2. Companies may pay out part of their profits to shareholders in the form of stock dividends. 

Types of Stocks

There are many stock types, and it’s generally a good idea to buy stocks from numerous categories — a tactic called diversification.

A diversified stock portfolio
(Image Source)

To simplify things, we’ll group the types of stock into a few broad categories, defined by four major features:

Style

There are different stock styles, such as:

  • Growth
  • Value
  • Income

Growth stocks come from companies focused on reinvesting their earnings to grow in value. They might pay dividends, but not always — and they tend to be smaller if they do.

Value stocks are less expensive than their financials and what other market conditions suggest. Warren Buffett is perhaps the wealthiest and most famous value investor alive. But, value can be calculated in multiple ways so what one person believes to be a value stock may not be considered one by someone else. 

Income stocks pay dividends out of remaining company profits to reward shareholders. For this reason, they’re also called dividend stocks. Income stocks are generally thought to be more stable than growth stocks, but this isn’t always true.

Location/nationality

The US isn’t alone in having stocks. You can invest in companies around the world. 

Emerging markets are often a hot topic of international investing since these developing economies are commonly poised for growth.

Industry

There are stocks in nearly every industry, sometimes called a sector in the investing world. 

Specific sectors may respond differently to current events or even to other sectors. 

For example, several stocks in the tech sector did well during the pandemic because people were at home using their products.

Company size

Company size is measured by market capitalization — market cap, for short. Market cap is the total number of shares multiplied by the stock price. 

You can break this into three categories:

  • Small-cap: $300 million–$2 billion
  • Mid-cap: $2 billion–$10 billion
  • Large-cap: $10 billion or more

The Benefits of Buying Stocks

Stocks are one of the most well-known types of investments around — and there’s a good reason for that. They offer plenty of benefits, as long as you invest according to a solid investment plan.

Here are some ways buying stocks can help you and the children in your life grow wealth and create a secure financial future.

Why you should consider buying stocks for yourself

Let’s look at five reasons why you should consider buying stocks for yourself:

1. Wealth growth

Historically, stocks have tended to beat other types of investments in terms of growth and returns. 

You can never know the future, but there is strong certainty that investing in the right allocation of stocks (as part of a broader investment strategy) can help you grow your wealth immensely over time.

Eventually, you could pass down some of your assets and create generational wealth for your future loved ones.

This is especially true in growing economies. A growing economy means companies are earning more profits, which generally pushes up stock prices and increases dividends.

2. Inflation

Every year, your money becomes a little less valuable. Prices slowly increase. 

This is called inflation.

Many people put money in savings accounts to earn interest, but these don’t always beat inflation — at best, a few match the inflation rate.

Thus, savings accounts won’t always help you preserve the value of your assets.

Inflation makes items cost more over time
(Image Source)

On the other hand, most stocks grow faster than inflation. 

You’re much more likely to be financially prepared for future goals like buying a home or retiring if you’re investing for the long term.

3. Diversification

Stocks are only one type of investment — there are many more. 

That said, they allow you to diversify a portfolio that contains other investments, such as bonds.

By diversifying within stocks and among asset classes, you can minimize losses when one market decreases. 

For example, when the bond market takes a hit, your stock holdings might increase — or at the very least, hold steady.

4. Ownership/voting rights

If you love a public company, you can express that loyalty by buying shares. 

For instance, if you’re a big Tesla fan, you can buy shares of the car manufacturer and become part-owner.

Stock ownership also lets you vote on company matters. This means you could be allowed to vote at shareholder meetings for any stocks you own.

Now, your vote might not do much when wealthier investors hold many more shares. 

However, you do have a voice in how companies are run. 

For socially responsible investors, this benefit is especially important. When working alongside other investors, they can influence companies to take actions that benefit various social causes.

5. Easy to buy and sell 

Today, buying and selling stock is easier than ever. 

You don’t need to phone up a broker to place trades — plenty of brokerage firms offer websites and mobile apps that allow you to buy and sell online with a few button clicks. 

Plus, many brokerages now offer fractional shares. If you can’t afford a whole share of an expensive stock, you can buy slices of shares over time. 

Similarly, the stock market is highly liquid, meaning it has a lot of people trading at once. It won’t be hard to buy or sell most shares because someone out there is on the other end of that transaction.

Why you should consider buying stocks for children

Now, let’s look at three reasons you should consider buying stocks for the children in your life:

1. Compounding and time horizon

Compounding simply means earning money on your money. The earlier you invest, the more money your money earns, which then earns even more, and so on.

A graph showing the power of compounding for your finances
(Image Source)

Most children won’t need to rely on their investments for years or even decades. They stand to reap huge rewards over such a long time horizon, thanks to the power of compounding.

Retirement is the most obvious example. If your child is 15 and plans to retire at 65, they have half a century to let their money grow and earn more money. 

Even if they want to buy a home at 35, that’s 20 years for their investments to get bigger and put that house within reach.

2. Greater risk appetite

Related to the time horizon is a concept called risk appetite. This simply means the amount of risk an investor is willing to take on to reach their goals.

Since children don’t often need the money for decades, more risk isn’t a big deal to them. And, more risk tends to bring more reward potential. 

They can put their money into riskier investments (such as a higher stock to bond ratio) that could potentially increase more in value, making compounding work even harder for them.

3. Learning opportunities

Warren Buffett once said, “Read 500 pages like this every week. That’s how knowledge builds up, like compound interest.”

He’s right. In addition to money, compounding also applies to knowledge.

At some point, the child in your life will have to learn to manage their personal finances and investment portfolio. Getting them into stocks early teaches them the basics of how the market works. 

It also helps them learn great habits, such as:

  • Living within your means
  • Setting aside money to save and invest
  • Checking your portfolio regularly (but not obsessing over it)
  • Gaining willpower in terms of sticking to an investment plan

Conclusion

Buying a stock simply means you’re buying a piece of ownership in a company. Whether you’re trading as a source of income or investing for the future, there are countless stocks you can choose from. 

Regardless of which stocks you buy, they remain one of the easiest assets to invest in. 

Adults can buy stocks to earn income, grow their wealth, and prepare for their financial future — assuming they follow a plan and diversify properly. 

You can also set up the children in your life for financial success by opening a custodial account and helping them buy stocks early on.

Want to learn more about setting up a custodial account and how loved ones can collectively invest in a child’s financial future? 

Download the EarlyBird app today to get started.

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