Perhaps the most common misperception among new investors is that stocks are simply pieces of paper to be traded. This is simply not the case. In stock investing, trading is a means, not an end.

A stock is an ownership interest in a company. A business is started by a person or small group of people who put their money in. How much of the business each founder owns is a function of how much money each invested. At this point, the company is considered "private." Once a business reaches a certain size, the company may decide to "go public" and sell a chunk of itself to the investing public. This is how stocks are created.

When you buy a stock, you become a business owner. Period. Over the long term, the value of that ownership stake will rise and fall according to the success of the underlying business. The better the business does, the more your ownership stake will be worth.

Stocks are but one of many possible ways to invest your hard-earned money. Why choose stocks instead of other options, such as bonds, rare coins, or antique sports cars? Quite simply, the reason that savvy investors invest in stocks is that they provide the highest potential returns. And over the long term, no other type of investment tends to perform better.

On the downside, stocks tend to be the most volatile investments. This means that the value of stocks can drop in the short term. Sometimes stock prices may even fall for a protracted period. Bad luck or bad timing can easily sink your returns, but you can minimise this by taking a long-term investing approach.

There's also no guarantee you will actually realise any sort of positive return. If you have the misfortune of consistently picking stocks that decline in value, you can lose money, even over the long term!

 

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Mark Lamonica is a product manager, Individual Investor, Australia.

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