Owning stocks is the bedrock of retirement planning for many people. Someone could own a few individual stocks or a variety of them in a mutual fund or exchange traded fund (etf). If you google “how do I save for retirement” you’ll find articles about “stock-heavy” portfolios and the “stock market” growth of the past decades. But what is a stock and what causes the value to fluctuate daily and often grow over time?
Stock in a company is sharing a percentage of ownership in the company. Apple, for instance, has over five billion shares outstanding. So that means that at a current price per share of about $106, owning one share would mean you own about 0.00000002% of the company. So for a fraction of the price of an iPhone, you can be an owner of one of the largest and most successful companies of all time.
Okay, so you own a miniscule percentage of a company that makes phones. How does that help your retirement?
There are two main ways that a stockholder makes money: dividends and appreciation of the value of the stock. Dividends are company profits given to shareholders, typically on a quarterly basis. The size of the dividend will vary based on the company’s profits and decisions of the board of directors (responsible for the shareholder’s best interest). Appreciation in value occurs when the stock price goes up. The stock price could be thought of as what someone is willing to pay upfront to receive dividends from a company in the future. That value can be somewhat arbitrary and depends on many factors such as the broader economy, that company’s prospects for future growth, and the opportunity for the company to make money by other means. We all pay a multiple of that company's earnings to be an owner of the future earnings. If Apple were to make $1/year in profit, I would pay more than $1 to own that profit for many years to come. How high a multiple? 5 times? 10 times? 25 times? Again, that depends on all sorts of factors that can be very difficult to accurately quantify.
Over the years, some companies may fail, others may prosper. There will be periods of losses and fear as well as boom years of large profits and optimism. That will cause the value of a stock to fluctuate. At its very core, owning stock in companies is betting on their future and by extension the future of our society as a whole. It is human nature to believe that we will continue to be productive and exchange goods and services of value with each other, causing the economy to grow. That is why owning stocks over decades presents such a great opportunity for long-term savings.