Common stock refers to the typical type of stock bought and sold on stock markets. It can be a good investment if you are able to pick companies that do well and either rise in value or pay out dividends to investors. On the other hand, disadvantages of common stocks are that they need to be picked through potentially time-consuming research and aren't as safe as putting money in lower-risk investments or bank accounts.
Advantages of common stocks include how easy they are to buy and sell, how they can help you save money and how they're governed by the long-term capital gains tax rate. Downsides include the potential to lose money due to market fluctuations.
How Common Stock Works
Common stock is the typical stock that you can buy and sell on a stock market like the New York Stock Exchange or Nasdaq exchange. It gives you limited ownership rights in a company according to how many shares, or units of stock, you purchase. That allows you to vote on certain governance decisions in the company.
More importantly from many investors' points of view, owning stock enables you to make money if the company grows in value, since the stock price will then typically go up, enabling you to sell for a profit. Stocks can also pay out dividends, which are shares of the company's earnings paid to investors according to how many shares they each own.
Advantages of Common Stock Ownership
If you can pick good companies to invest in, owning stock can be a good way to make money to save for retirement or simply build your net worth. When companies rise steeply in value, you can make more money than by simply putting your money into a bank account or investing in lower-risk investments such as bonds, which are effectively loans to companies or government agencies.
Stocks are also easy to buy and sell, provided you invest in major publicly traded companies. They are easy to liquidate if you need cash compared to more tangible investments like art, real estate and collectibles.
Sale of stock that you've owned for more than a year and certain dividends are also governed by long-term capital gains tax law, which for most investors enables you to pay a lower tax rate on those gains than you would pay on the same amount of income from another source, like your salary or bank interest. Check with a tax advisor or lawyer for details on the tax ramifications of your investments.
Disadvantages of Common Stock
Buying stock can be riskier than some other investments. If a company stops doing well, your stock could decline in value or even become entirely worthless. Stock value isn't insured the way bank accounts are insured by the Federal Deposit Insurance Corporation, and stockholders generally get paid last if a company is attempting to settle its debts after bankruptcy. If you're worried about losing money, it may make more sense to invest in something lower risk like a bond from a highly rated company or agency or simply keep your money in the bank.
Buying and selling stock for profit also requires paying some attention to market conditions and how particular companies are doing, which takes time that you could be spending on other tasks or simply relaxing. If you're not interested in keeping up with how different companies are performing, it may make more sense to invest in a mutual fund, where experts pick stocks for you, or an index fund, which invests in stocks according to some formula.
Understanding Preferred Stock
Some companies issue multiple classes of stock. Some may issue shares with more voting rights in a company or may issue preferred stock, which can get dividends paid at a higher rate than common stock.
There are advantages and disadvantages of preferred stock and common stock alike. Preferred stock often gets paid dividends at higher rates, but it can be harder to trade and may not carry the same voting rights as common stock.