When you invest in a company’s stocks, you essentially buy a piece of the company. With the company’s growth, one can hope that the stock would start giving returns and your investment would turn out to be fruitful. However, you need to be aware of the advantages and disadvantages of stock investment. Visit to learn more about shares
Traditionally, the stock market is known for delivering good returns consistently but it also goes through low points, and thus investors need to be prepared for both profits and losses.
Advantages of investing in stock
Stock investment offers plenty of benefits:
- Benefit from a growing economy: With the growth in the economy, corporate earnings also get a boost since economic growth leads to job creation. This in turn generates income which further drives sales. Healthy paychecks imply a steady consumer demand which increases revenue for companies. It also makes it simpler to understand the different phases of the business cycle—expansion, peak, contraction, and trough.
- Stay ahead of inflation: It has been observed over the years that long-term stocks have brought in hefty annualized returns. For instance, if we go by the numbers of January 31, 2022, the 10-year annualized return for the S&P 500 has been 15.43%. This is a good number that is much higher than the average annualized inflation rate. It implies that you need to have a window of time so you’re able to buy and hold even if the value drops for some time.
- Easily accessible: Buying company shares is easier in the stock market. You will be able to buy them with the help of a broker or a financial planner, or you may even choose to do this online. After setting up your account, stocks can be purchased in a matter of a few minutes. Small business owners might have the option to invest in stocks through their business.
- Minimum investment required: A majority of retail brokers allow you to buy and sell stocks without any commission. There are certain brokers that do not need any account minimums. If you’re eyeing a rather expensive stock, you may want to explore the option of buying fractional shares.
- Make money in multiple ways: Typically investors prefer to buy low and then sell high. They put their money on companies that are growing at a good pace and whose value is also appreciated over time. A company like that would grab the attention of both day traders as well as buy-and-hold investors. The first group would attempt to make the most of short-term trends, while the other one would be more patient as they wait for the company’s earnings and stock to rise in due course. Both are of the opinion that their stock-picking skills help them outperform the market. Other investors choose to have a steady cash flow. Hence they like to buy stocks of companies that pay dividends to their investors. These companies tend to have steady, moderate growth.
- Liquidity: You have the liberty to sell your stock at any point of time in the stock market. Economists refer to this aspect of the market when they talk about liquidity. This implies that your shares can become cash swiftly with low transaction costs. This could be helpful if you’re in need of funds all of a sudden. Volatile prices indicate that you may have to take a loss.
Some of the disadvantages of investing in stock
Here are the disadvantages to owning stocks:
- Risk: Your entire investment is at risk. If a company fails to perform well, investors will sell, which would send the stock price down. When you sell at this point you may end up losing parts of your starting capital. Invest in bonds to hold on to that initial capital.
- Common stockholders are paid last: Select stockholders and bondholders or creditors are the ones paid out first if a company goes bankrupt. Maintain a well-diversified portfolio to avoid such a situation.
- Time: Make sure you carry out thorough research about the companies you’re investing in, if you choose your stocks on your own. Establish how profitable they may be before you put your money on them. Develop the habit of being able to read and analyze financial statements and annual reports to grasp your company’s situation.
- Taxes: Sell your stock for a loss and the taxman would not come after you. But if you’re making a profit out of your sales in the stock market, be prepared to pay capital gains taxes.
- Emotional roller coaster: Stock prices fluctuate rapidly. Investors often make the mistake of buying high because the returns look good and sell low out of fear of a further crash. Learn the difference between checking the market constantly and keeping a regular check to save yourself from getting into an emotional whirlwind.
Diversify your investment to minimize risk
Though stocks are a risky investment as compared to bonds, the investment risk can be brought down by diversifying your portfolio. Diversification implies that you put your money in various types of assets, across several sectors to minimize risk. If a particular kind of stock’s or asset’s value goes while other types of investments remain steady, the overall impact on your portfolio is significant.
Here’s how you can go about diversifying your stock investments:
- By investment type: A well-diversified portfolio will bring in a majority of benefits and a lesser number of disadvantages than just stock ownership. It implies that investing in a mix of stocks, bonds, and commodities is a wise thing to do. In the due course, it turns out to be a great way to earn good returns at minimum risk.
- By company size: There are three types of companies: large-cap, mid-cap, and small-cap. The term “cap” indicates “market capitalization.” It refers to the overall stock price multiplied by the number of shares. You should try to own different-sized companies as they would respond differently in every phase of the business cycle.Say for instance, large-cap companies are typically stable and less likely to be impacted by share price volatility. Whereas, small-cap companies turn out to be riskier and prone to share price volatility while also bringing much higher growth potential.
- By location: Buy stocks of companies that are based out of the United States, Europe, Japan, and developing markets. Diversification helps you make the most of the growth without risking it all in a particular geography.
- Through mutual funds and ETFs: Owning mutual funds or exchange-traded funds (ETFs) lets you buy hundreds of stocks chosen by your fund manager. Use index funds or index ETFs to diversify your portfolio easily.