How do stocks work? It’s time to learn how stocks work so you boost your portfolio returns

Have you ever wondered, “How do stocks work?”

Stocks are financial instruments that let you hold an ownership stake in a publicly traded company. A stock you own gives you an effective claim on the earnings and assets of a company.

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How do stocks work in the market?

A stock market is an exchange on which shares are issued and then traded. Stock markets are also known as equity markets.

Stocks trade on financial markets. The price of a stock usually fluctuates throughout the trading day depending a number of factors such as economic sector news, geo-political developments, and company-specific news.

Stock market predictions are terrible at determining what effect changes will have on an industry. It’s even harder to predict how long those changes will take to appear. Of course, adverse changes are hardest on companies with bad financing, poor products, weak management or other drawbacks. Meanwhile, successful companies figure out ways to adapt and even profit from change.

Most successful investors agree that it’s a good idea to base investment decisions on facts rather than stock market predictions. You can make mistakes with facts, of course, but predictions have a much higher failure rate.

How do stocks work in relation to bonds?

There are no guarantees with stocks, but our view is that stocks are a better financial choice for most investors than bonds—even if you hold those stocks in financial instruments like ETFs, mutual funds and index funds.

In fact, we’d say the only investors who should hold significant quantities of bonds are those who simply cannot stomach the thought of sitting through a noticeable decline in the value of their portfolios. If you fall in that category and want to own bonds, our advice is to keep the maturities on your bonds below three years.

That way, a rise in interest rates, and/or a rise in inflation, can’t do too much harm to the value of your portfolio.

How do stocks work in your portfolio?

When building a portfolio, the first thing you need to do is to decide how much of your money to put in equities (that is, stocks and ETFs that invest in stocks), and how much to put in fixed-return investments such as bonds and money-market instruments.

One of our key rules for successful investing is to maintain a diversified stock portfolio. You should spread your money out across most, if not all, of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities.

Note that when it comes to a diversified stock portfolio, stocks in the Resources and Manufacturing & Industry sectors expose you to above-average volatility.

Stocks in the Utilities and Canadian Finance sectors entail below-average volatility.

Profits of Canadian Finance and Utilities firms tend to be more stable than profits of Resources or Manufacturing companies.

Consumer stocks fall in the middle, between more volatile Resources and Manufacturing companies and more stable Finance and Utilities companies.

Stock portfolios should include investments in most, if not all, of these five sectors. The right proportions for you depend on your temperament and circumstances.

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How do you see stock investing? A gamble and a game, or something that can be manipulated and won?