Advantage & Disadvantage for Common Stock Ownership

by Julie Davoren Google

    According to a Gallup poll published in April 2011, 87 percent of Americans earning $75,000 and up have invested in stock. The poll goes on to reveal that 83 percent of postgraduates and 73 percent of college graduates own stock. This implies some advantage to owning stock. Most stock traded is common stock. Investing in common stock requires some analytical skills, but they can be acquired by anyone sufficiently interested in making the effort.

    Definitions

    Corporations issue two types of stock — common and preferred. Common stock endows the owner with rights to the earnings and assets of the corporation and typically represents one vote toward the election of the corporation’s board of directors. Corporations have a degree of latitude in defining the rights conveyed to purchasers of its stock. In short, all shares are not created equal, and a common shareholder’s rights can vary among corporations. In the hierarchy of ownership, common stock is the lowest rung on the ladder. This means that if the corporation liquidates, bankrupts or otherwise fails, the common shareholder will receive no distribution of assets until bondholders, preferred shareholders and creditors have been paid in full.

    Advantages

    When you invest in stock, you have history on your side. History has shown that practically no other security performs better over the long term, with stocks averaging a return of nearly 10 percent annually, according to Money Magazine. Investing in stock comes with many other advantages. For one, purchasing stock is convenient. You can do it from the comfort of your own home via the Internet, through brokers and, in certain instances, directly from the company. It also offers variety. There are more than 11,000 publicly traded companies in North America alone and even more choices globally. Another advantage is transparency. Companies offering stock to the public are required by law to provide you with a prospectus, which you should review carefully.

    Risks

    Common stock is riskier than many other investment options, although it can also lead to greater rewards. However, the increased risk can be regarded as a disadvantage, and as an investor the risk vs. reward paradigm must meet your comfort level and correspond favorably to your financial ability to absorb any losses that may occur. Equally important are your investment goals. Goals such as saving for retirement, your children’s college education or a vacation home may determine the degree of risks you are willing to shoulder. You might be willing to accept a higher risk to earn the vacation home, but if the goal is retirement or education, you might want to mitigate your risk.

    Considerations

    An investor may choose to buy stock for many reasons, including anticipation that your investment may appreciate in value. Also, you may be looking for an income stream or you may want liquidity. Stock can meet all these objectives. However, unlike an investment in Treasuries, certificates of deposit or savings accounts, an investment in common stock places principal as well as future earnings at risk. Your $75 investment in a share of XYZ Company today could be valued at $50 next week. If you bought the stock because of an attractive dividend, you must accept the possibility of the company’s board of directors voting to reduce or discontinue it.

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    About the Author

    A technical business analyst since 1995, Julie Davoren began her writing career in 2009. She writes technical articles and travel articles for various websites. Davoren studied accounting at Point Park University and computer information systems at the University of Phoenix.

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