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As an investor in a stock mutual fund, you essentially own a small portion of
the mutual fund company's portfolio of multiple stocks. This article will discuss
concepts related to stocks and stock ownership. For more information about stock funds please see
Stock Mutual Funds
During the bull market of the 1990s, the investment of choice was stocks.
For example, on January 2, 1990, the Dow Jones
Industrial Average closed at 2,810.15.(1). At the end of the decade
on December 31, 1999, it closed at 11,497.12, an incredible 409%
increase during those 10 years!(2) Although some of those gains were lost by April
and May of 2002, it was remaining around the 10,000 mark.
For anyone who has never invested in stocks or has done so on a
limited basis, it is easy to maintain a perception that the stock
market is a dangerous place where the average investor can literally
lose his or her shirt at the expense of sophisticated stockbrokers,
insiders and investors. And sure enough, stock prices go up and
down, occasionally plummeting. Many investors remember the 508-point
crash on October 19, 1987 and the 554-point drop on October 27,
1997.(3) More recently one can point to the dotcom crash
of 2000, or the market correction followin the September 11 terrorist attacks.
The potential for increases in value as well as decreases
varies from company to company and type of industry to industry.
Nevertheless, there are millions of small investors who have
profited from investing in stocks or in mutual funds that buy
stocks. They have been able to realize personal and family goals
that might otherwise have been unachievable because of the increased
value of their stocks and the dividend income they provide.
But, what are stocks? The purpose of this feature is to answer
that question.
Stocks represent an ownership interest in a company. Accordingly,
stocks are often called equities because stocks represent an
equity interest in a company. As an owner of stocks (also known as a
stockholder or shareholder), you are one of many
people in addition to financial institutions such as pension funds
and insurance companies, that own stock. Companies issue shares of
common and preferred stock (discussed below) to raise money from
investors in order for the business to grow and expand. As an owner
of the company, the dollar value of your shares of stock will rise
and fall as other investors buy and sell shares based on their
opinions of the company's future.
As an owner, you will generally receive quarterly and annual
reports that reflect how your company is doing and its outlook for
the future. Also, as an owner you will be invited to vote at the
company's annual meeting on important business matters. At most
companies, a stockholder gets one vote for each share of stock
owned. As a result, don't expect to influence the company's
decisions and direction unless you have a substantial ownership
interest.
In addition to the potential for appreciation in value of your
shares, you can also earn money from dividends paid. If the
company is profitable and decides to share its profits with the
stockholders, you will receive a dividend check as your share of the
company's profits.
Periodically, companies declare a stock split. For
example, in a 2-for-1 stock split, two new shares of stock are
exchanged for each old share. Stock splits occur when a company
wants to lower the market price of its stock because the company
believes the price of its stock is too high for many investors to
purchase. As stock prices decline as a result of the split, the
stock potentially becomes more attractive to a larger group of
investors and market price may rise as a result.
With that as background, let's look at the two basic types of
stock: preferred and common. Both types provide the
opportunity for appreciation in value, dividend income and possible
stock splits.
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Preferred stock - is called 'preferred' because the owner is
granted rights or preferences not provided by common stock.
Examples include the right to be paid dividends before owners of
common stock; if preferred dividends are periodically not paid,
all unpaid and current dividends must be paid before dividends can
be issued to owners of common stock; the right to exchange
preferred shares for a fixed number of common shares; and in the
event the company is closed and its assets liquidated, claims of
preferred stockholders are satisfied before claims of common
stockholders.(4)
The price of preferred shares tends to be more stable than
common shares because preferred shares generally pay a fixed
dividend that does not rise over time in contrast to dividends on
common shares that can fluctuate. Since preferred shares have
greater price stability, they do not offer as much potential for
increases and decreases in value as common stocks.
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Common stock - the more commonly issued form of stock.
Generally only common stockholders have voting rights concerning
company matters. As the ultimate owners of the company, any funds
not paid out to creditors, preferred stockholders and other
investors such as bondholders automatically belong to the common
stockholders.(5)
Endnotes:
(1) Jennifer Oldham, 'A History of the Dow,' Los Angeles Times, March 30, 1999, p. C6.
(2) Tom Petruno, '1999 Goes Into the Record Book on Wall Street,' Los Angeles Times, January 1, 2000, p. C1.
(3) Jordan E. Goodman, Everyone's Money Book, copyright 1998, p. 95.
(4) Robert Garner, Robert Coplan, Barbara Raasch, Charles Ratner, Ernst & Young's Personal Financial Planning Guide, copyright 1995, p. 74.
(5) Dearborn Financial Publishing, Inc., Principles of Retirement Planning, copyright 1997, p. 97.
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