Investing in stocks or the stock market or related pooled funds such as equity funds and index funds has the potential of creating and growing wealth compared with investing in other assets or securities such as bonds and the money market.
Stocks provide higher returns in general. However, with high returns come higher risks. This is the so-called risk-return trade-off. Nevertheless, this article outlines the advantages and disadvantages or pros and cons of investing in stocks.
Pros: Advantages of Investing in Stocks
Potential to Outpace Inflation
Saving in banks and similar products such as time deposits is the best route to losing money because of inflation. Other low-risk to moderate-risk investment vehicles such as certain bonds have returns that are lower than the inflation rate.
Numerous comparative analyzes of the historical performances of different investments have shown that stocks often outperform other investment vehicles in terms of returns while demonstrating a considerable potential for beating inflation.
Of course, inflation has an impact on stocks. It is important to have a portfolio that adapts to market conditions. Analysts have noted that value stocks perform better during periods of high inflation while growth stocks are more suitable when inflation is low.
Adaptable to Economic Conditions
The stock market remains a high-risk investment option because of its volatility. However, this can be an advantage. Another benefit of investing in stocks is the availability of options that can be factored into an investment strategy that adapts to the condition of the economy.
For example, during periods of economic expansion, the consensus is to invest in stocks or pooled funds composed of stocks to reap the benefits of a growing economy. During periods of crisis and recession, it is still best to invest in stocks.
Both economic crisis and economic recession result in low stock prices. The value of most of these stocks has the potential to appreciate once the economy recovers. Note that certain industries and sectors are even unaffected by recessions.
Examples of industries and sectors that perform well during economic downturns are healthcare, food production, basic transportation, utilities, and other consumer staples. It is best to buy stocks in companies operating in these markets.
Relative Ease in Investing in Stocks
There are two ways to invest in stocks: either by buying them directly through a stockbroker or by investing in pooled funds such as equity funds and equity index funds. Both are arguably easy to do because of the availability of service providers.
An individual can purchase stocks online via an online-enabled broker or trading platform. There is a large selection of websites and apps developed and maintained by brokerage companies. He or she can also opt to purchase stocks via a portfolio manager.
Investing in pooled funds is easier. Different financial services companies offer pooled fund products such as mutual funds and unit investment trust funds. Several insurance companies offer pooled funds attached to investment-linked insurance policies.
Wealth Generation and High Liquidity
Creating and growing wealth through stocks within a medium-to-long-term timeframe transpire because of capital appreciation. There are also income-generating stocks that provide investors with a passive income stream through dividends.
Several billionaires in the United States have amassed wealth from the stock market. Examples include John Paulson, Warren Buffett, James Simons, Ray Dalio, Carl Icahn, and Dan Loeb. Note that Buffett is a staunch advocate of stock market investing.
Another advantage of investing in stocks is that it is more liquid than assets like real estate or commodities such as gold and oil. To illustrate, a real estate property takes time to liquidate because the owner needs to list it first and wait for potential buyers.
The purchased stocks can be converted to cash via a sell order either through a broker or trading platform. Those who have investments in pooled funds can readily withdraw from their accounts as if they are transferring money across bank accounts.
Cons: Disadvantages of Investing in Stocks
Inherent and Notable Risks
Of course, it is important to reiterate the fact that stocks are high-risk investments that have the potential to provide higher returns versus low-risk and medium-risk investment options. This is called the risk-return tradeoff.
There are several risks inherent to stocks. For starters, the stock market is volatile. The prices of stocks and the performance of the overall market can be affected by a range of external factors, as well as internal factors involving relevant companies, industries, and sectors.
An individual has the potential to lose the value of his or her investment during a market rash. Some can even lose their money and wealth due to poor-performing stocks or whenever they sell stocks in response to a greater economic downturn.
Necessitates Research and Expertise
Remember that ease is an advantage of stock investing. However, one should note that another disadvantage of investing in stocks is that doing so would require a certain level of skills and knowledge to guide investment decisions.
It is important for potential and existing investors to research the stocks they intend to buy or the companies they are planning to invest in. Most hire the expertise of financial advisors such as portfolio managers. Others depend on professional fund managers.
Seeking the expertise of professionals involves costs such as commissions and management or handling fees. Some take the do-it-yourself path but this can also consume time and may be unsuitable for those with full-time occupations.
Takes Time and Unguaranteed Returns
Investing in stocks is most suitable for medium-term to long-term timeframe of at least 8 to 15 years and onwards. One should not expect to get rich within a shorter period. Stock investing has the potential to create wealth but it is not a get-rich-quick scheme.
Returns are determined by the power of time, as well as the impact of compounding. Remember that stocks have the potential to increase in value through capital appreciation while also generating passive income through dividends.
However, returns are not guaranteed. The stock market is volatile and economies go through a cycle of expansion and recession. It is important to give investments in stocks time to recover during market and greater economic downturns.
Costs Associated with Stock Investing
Inventors should also remain aware of the costs or fees and other financial liabilities associated with their investments. It is important to keep track of them to ensure maximum returns or profitability. Note that all investment options and vehicles have costs.
For example, in investing in stocks, active investors and traders can be liable to pay capital gains taxes, particularly if they sell the stocks they held for a profit. Selling stocks for a loss can grant investors with tax breaks or exemptions.
Other fees associated with stock investing include brokerage fees for stockbrokers, management fees and commissions or performance fees for portfolio managers, fund managers, or advisors, and transaction fees for active buy-and-sell activities.