Benefits of Investing in Stocks Versus Disadvantages
Five Benefits and Five Disadvantages of Owning Stocks
There are five benefits of stock investing.
- Stock ownership takes advantage of a growing economy. As the economy grows, so do corporate earnings. That's because economic growth creates income. The fatter paycheck boosts consumer demand, which drives more revenues into companies' cash registers. It helps if you understand the phases of the business cycle.
- They are the best way to stay ahead of inflation. Historically, stocks have averaged an annual return of 10 percent. That's better than the average annual inflation rate of 3.2 percent. It does mean you must have a longer time horizon. That way, you can buy and hold even if the value temporarily drops. Compare stocks, inflation, and the gold price in history.
- Easy to buy. The stock market makes it easy to buy shares of companies. You can purchase them through a broker, a financial planner, or online. Once you've set up an account, you can buy stocks in minutes. But first, learn how to invest in stocks.
- You make money in two ways. Most investors intend to buy low and then sell high. They invest in fast-growing companies that appreciate in value. That's attractive to both day traders and buy-and-hold investors. The first group hope to take advantage of short-term trends, while the latter expect to see the company's earnings and stock price grow over time. They both believe their stock-picking skills allow them to outperform the market. Other investors prefer a regular stream of cash. They purchase stocks of companies that pay dividends. Those companies grow at a moderate rate.
- They are easy to sell. The stock market allows you to sell your stock at any time. That's important if you suddenly need your cash in a hurry. Since prices are volatile, you run the risk of being forced to take a loss.
There are five disadvantages to owning stocks.
- You could lose your entire investment. If a company does poorly, investors will sell, sending the stock price plummeting. When you sell, you will lose your initial investment. If you can't afford to lose your initial investment, then you should buy bonds. You get an income tax break if you lose money on your stock loss. Unfortunately, you also have to pay taxes if you make money. You pay the capital gains tax.
- Stockholders are paid last if the company goes broke. Preferred stockholders and bondholders get paid first.
- It requires a lot of time. You've got to research each and every company to determine how profitable you think it will be before you buy stock. You've got to learn how to read financial statements and annual reports, and follow your company's developments in the news. You also have to monitor the stock market itself, as even the best company's price will fall in a market correction, a market crash, or bear market.
- It can be an emotional rollercoaster. Stock prices rise and fall every second. Individuals have the tendency to buy high, out of greed, and sell low, out of fear.
- You compete against professionals. Institutional investors and traders have more time and knowledge to invest. Find out how to gain an advantage as an individual investor.
A well-diversified portfolio will provide most of the benefits and fewer disadvantages than stock ownership alone. That means you should have a mix of stocks, bonds, and commodities. Research shows that, over time, it's the best way to gain the highest return at the lowest risk. Find out how bonds affect the stock market.
You should also own different types of stocks. That includes large cap, mid cap, and small cap companies. Own companies located in the United States, Europe, Japan, and emerging markets. It allows you to take advantage of growth without being vulnerable to any one stock.
Another way to gain diversification is through mutual funds. That allows you to own hundreds of stocks that are selected by the mutual fund manager. That means you are less vulnerable to any individual stock's performance.
How much of each should you have? Financial planners suggest that you establish your asset allocation based on your financial goals. You should also respond to changes in the business cycle. Be aware where the economy is in the current business cycle.