Why invest in stocks? What are the advantages of investing in stocks and the benefits of buying shares? Are there disadvantages to investing in stocks?
This article will show you the key benefits of investing in stocks and the potential disadvantages of investing in stocks.
The benefits of investing in stocks are many. You may wish to build a nest egg so you can enjoy a comfortable retirement. You could repay your mortgage earlier or use the money for college or university fees for your children.
But how easy it to make money from buying stocks and shares? After all, you are making stock market predictions, and there are many advantages and disadvantages to investing with the stock exchange.
Successful stock investors tell us to diversify our financial portfolio. So, adding stocks to your investments can be a valuable part of growing your portfolio. With investment diversification, it makes sense to spread the risk and maximise the potential from owning stocks for a few different companies.
Investing in stocks can be risky, especially if you have no investment knowledge or experience. If you want to build your hard-earned savings, it pays to understand what to look for when buying stocks. Along with the benefits of investing in stocks, you must assess your tolerance to risk.
Different stocks have different benefits, and it is essential to know which stocks are best for your investment portfolio.
In conclusion, you will know the benefits of investing in stocks, the risks of investing in stocks and how to diversify your stock portfolio.
Contents
What are the Advantages of Investing in Stocks?
In the past, you may have invested your money in cash saving accounts, ISAs etc., where you would get a guaranteed return. It's a safe way to invest, but the cash returns are small unless you have a significant amount of money to put into savings.
The downside of cash savings is that your rate of return has to exceed inflation for your account to make financial gains. And, for some time now, this has proved challenging.
The benefits of investing in stocks are that it can bring far greater long-term returns, but there are no guarantees, and there is a high degree of risk. You could lose some or all of your money by investing in stocks. If your risk tolerance is low, you may panic, sell the stock prematurely, and then watch as the share price rockets.
The stock market is volatile, which means that stock prices can change quickly.
But, in many ways, volatility is necessary to make profits from investing in stocks.
If there were no stock market volatility, prices would remain static. That would make it harder to gain profits from investing in stocks. When share prices drop significantly, this can present an opportunity to invest in stocks at a much more attractive price.
There are many other benefits of investing in stocks. You may be looking for a regular income in retirement. You can diversify your financial portfolio by investing in property, bonds or equities.
And you don't have to do it on your own.
You can hire an investment manager who will help you build your investment portfolio tailored to your financial needs and risk tolerance. Over time, you can adapt your investment portfolio as your financial circumstances change.
There are even more benefits from investing in stocks if you think long-term. And by long-term, think years rather than months.
Stock prices fluctuate every day, so they are less attractive to the investor for short-term gains. It can be challenging for the new investor to ride out the price highs and lows without selling their stocks in a panic.
The trick is to invest in stocks with money you can afford to lose and don't need any time soon. Allow the stock price to smooth out over time, and the benefits of investing in stocks show in the long-term profits.
Read Also: How To Invest In Stocks - A Beginner’s Guide To The Stock Market
Are There Other Benefits of Investing in Stocks?
Investing in stocks has never been so easy. But, one thing to be aware of when investing in stocks is the tax implications.
Investing in long-term equities is far more beneficial for tax purposes and the adverse effects of inflation.
There are many benefits to investing in stocks
- Stocks are easy to buy - even for the novice stock investor, it isn't difficult to identify stocks with liquidity and volume. You can purchase stocks via a broker or a financial planner. You can buy stocks online and use a stock screener to filter out the stocks with profit potential, and you can set your parameters for the stock screener searches
- Stocks are easy to sell – the stock market is liquid, which means you can sell your shares at any time if you want to take your money out
- Grow with the economy – Investing in stocks can help your investments grow with the economy and stay ahead of inflation. Corporate earnings increase as the economy grows. Economic growth means more jobs, which creates more income and sales. Cash savings can be affected by inflation and reduce potential revenue, but stocks can continue to grow, dependent on company growth, innovation and investment
- Stay ahead of inflation – to make a capital gain, your investment results need to be greater than inflation. Typically, stocks return 10% annually, which is better than the average annual inflation rate
- Two ways to make money – investors typically buy low and sell high investing in fast-growing companies. Short term investors like day traders take advantage of the fast growth by capitalising on small price fluctuations. Long-term investors can buy and hold stocks for more significant returns, and they may prefer to seek slower-growing, more established companies that pay out dividends
Check Out: 7 Tips On When To Buy A Stock And When To Sell A Stock
There's no quick way to get started investing in and profiting from stocks.
It takes time to research potential stocks and, even if a stock looks good on paper, there is still the associated risk of losing your money if the stock price falls. Investing in stocks can bring emotional highs and lows and is not for the fainthearted or short-term investor.
Some companies share a portion of their profits by paying dividends to their shareholders.
Depending on the level of your investment, these dividends can contribute a regular income from your investments. Not all companies pay dividends, so it is worth checking before you invest in stocks.
Emerging or growing companies are less likely to pay dividends because they reinvest their profits back into the business. These companies may be worth tracking for future investment. But, if you want regular income from dividends, emerging companies aren't the better option.
The Advantages of Dividends
- Better Returns – regular dividends from your stocks increases returns on your investments
- Better Stability – companies that manage their cash flow effectively find it easier to maintain, or grow, dividend payments. Companies showing stable earnings and growth tend to lead to increased share prices over time.
- Lower Volatility – dividends can reduce volatility as they help to support the stock price
- Regular Income – dividends from investments can provide you with a regular income
What are the Risks of Investing in Stocks?
Investing in stocks is an attractive option for the long-term investor, but as well as the benefits of investing in stocks, there are associated risks.
Every good financial advisor will tell you only to invest money you can afford to lose.
To make good returns from investing in stocks, it could take a few years. That isn't always the case, but it's the typical expectation from investing in stocks.
Whilst you want to know the benefits of investing in stocks, it's crucial to understand the risks:
- You could lose your investment – there are no guarantees for company growth. If company results are poor, the stock price may fall, even plummet to new lows. If you sold at that low, you could lose your entire investment. If the company goes bankrupt, you are unlikely to see your money again
- Capital Gains Tax – yep, you have to pay capital gains tax if you make money from your stocks. That's why short-term gains are less attractive to the investor than long-term gains and why companies offering dividends are a preferred option for investing in stocks – you pay less tax on income from dividends
- Stockholders are the last to be paid – creditors and preferred stockholders are paid first if the company goes bankrupt. One way to reduce the risk of this is to have a diverse portfolio. Never put all your eggs in one basket and rely on one company to bring financial returns from investing in stocks. Therefore, if one company collapses, you haven't lost everything in your investment portfolio
- It's time-consuming – buying stocks on a whim is a way to lose money. So the savvy stock investor spends significant time researching each company and assessing potential probability for profitability. You have to learn to read financial statements and annual reports and track company developments. Then, you have to monitor the stock market itself because if a market correction (such as a stock market crash) occurs, it will affect all share prices
- Investing in stocks can be an emotional rollercoaster – second-by-second, stock prices are rising and falling. The stock market is driven by sentiment. Individual investors with little experience tend to buy stocks out of greed or fear. They buy at too high prices, such as they see a share price rising and, rather than wait for the price to drop back, they jump into the market and buy the stock. Then the price comes back, and they lose their investment. One way to avoid the emotional rollercoaster is to commit to checking your investments once a day and not constantly looking at the prices and fretting if they are going the wrong way
- You're competing with Professional Investors – there are many professional and institutional stock traders with the time, experience and knowledge to invest in stocks successfully. They know how to gain an advantage over the stock market by using highly sophisticated trading tools and systems and good working financial models for investing in stocks.
There are many benefits of investing in stocks, but it is crucial to weigh up the disadvantages of investing in stocks and assess your risk tolerance.
How do I Diversify My Stock Portfolio?
One way of reducing the risks of investing in stocks is to diversify your stock portfolio.
There are many ways to lower investment risk.
Below are four ways to diversify your stock portfolio:
- Mix up your Investments – diversifying your stock portfolio gives you more benefits from investing in stocks and fewer disadvantages than owning stocks as stand-alone. Mix up your investments with bonds, stocks and commodities. Diversifying your investment portfolio spreads the risks. So, if you lose money on one financial instrument, your portfolio doesn't fall apart
- Invest in variable-sized companies – Invest in small-cap, mid-cap and large-cap companies (Cap is an abbreviation for capitalisation, which is the total stock price times the number of shares available). The different sized companies perform differently from each other in the business cycle
- Buy stocks by location – diversify your portfolio into different countries, such as Europe, United States, Japan and other emerging markets. The benefits of investing in stocks from different locations mean reduced vulnerability and risk.
- Invest in mutual funds – a mutual fund means you own hundreds of stocks rather than a handful you have chosen. A mutual fund manager can set you up with a mutual fund. You could also diversify with Index funds or Index ETFs
Different Stocks have Different Benefits
There are two main types of equity investments. Each one offers different benefits to investors.
1. Common Shares
Common shares are the most popular equity investment through shareholders.
The company issues shares to investors as proof of money that they have paid into the company.
The downside is that the common shareholders are at the bottom of the pile with the least claim on company assets.
Common shares offer:
Capital Growth – as stock prices rise and fall, common shareholders can decide to sell their shares for a profit
Income from Dividends – dividends are a good source of tax-efficient income for investors, and many companies pay shareholder dividends
Voting Privileges – with voting rights, shareholders have some influence over who runs the company
Good Liquidity – makes it easier to buy and sell common shares than other investments such as art, jewellery or real estate. That means an easy and quick release as cash for the common shares investor
Tax Benefits – Income from dividends and capital gains are taxed at a lower rate than interest income from bonds or GICs and lower than employment income
2. Preferred Shares
Preferred shares are also known as preferred stock.
Preferred shares are the shares of the company's stock with dividends paid out to shareholders before the common stock dividends are issued.
Typically, preferred shareholders do not have voting rights
The benefits of preferred shares are:
- Reliable income stream - preferred shares have a fixed dividend amount that the company must pay before paying dividends to common shareholders.
- Higher income Potential – preferred shares typically pay higher dividends than common shares. Tax benefits on dividends are the same as for common shares
- Variety – there are multiple types of preferred shares with different features. For instance, some preferred shares allow the shareholder to accumulate dividends, and some preferred shares can be converted into common shares
Recap of Key Benefits of Investing in Stocks
Is investing in stocks a good idea?
There are many key benefits of investing in stocks and buying shares. But weighing up the advantages and disadvantages of investing in stocks is the first step to consider for the new investor considering investing in stocks and shares.
There are many advantages of stock market prediction if you are ready to invest in stocks for long-term growth. Stocks are easy to buy and sell. You can invest in stocks via a financial planner or purchase from a broker online.
Stocks grow with the economy and historically stay ahead of inflation.
Some companies issue dividends to their shareholders. Dividends have tax benefits as the taxation rate is lower than employment tax.
Dividends provide better returns and improved stability. Dividends lower volatility as they support the stock price, and, last but not least, dividends are a great way to create regular income.
There are downsides to investing in stocks.
Investing in stocks comes with risks, notably the risk of losing your investment capital. Shareholders are the last to be paid, and if a company goes into bankruptcy, you will likely lose your money as creditors, and preferred shareholders get paid first.
Investing in stocks can be an emotional rollercoaster and is not advised if you have a low tolerance for risk. Investing in stocks can bring greater long-term returns from cash saving accounts such as an ISA. You do have to pay capital gains tax on income from stocks and shares.
To reduce the risks of investing in stocks, it pays to mix up your investments with financial instruments such as bonds, stocks and commodities. Invest in small-cap, medium cap and large-cap companies as they all perform differently.
Invest in stocks by different countries as this reduces the risk of vulnerability if the country of origin for your stock encounters an economic crisis.
If you don't have time or the skill to research stocks for investment, one option is to invest in a mutual fund whereby you own hundreds of stocks instead of investing in a few stocks on your own.
A mutual fund manager is an experienced investment planner who can help you decide the best ways to invest in stocks.
Different stocks have different benefits. Common shares are the most popular option for investors, and the shareholders have voting privileges.
Preferred shares offer a more reliable income with fixed dividends and higher returns, and a wider variety of choices. For instance, a preferred shareholder can choose to reinvest dividends and build up profits. You can convert preferred shares into common shares
Once you decide to invest in stocks, the advice from investment experts is to diversify your investment portfolio.
Please note that the above information is not providing advice on tax, investment, or financial services. We provide the above information without consideration for risk tolerance and a specific investor's financial circumstances.
Trading or investing in financial instruments such as stocks, ETFs and commodities may not be suitable for all investors. It does involve risk and the possibility of a loss of capital.
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