Stock market investing is inherently risky. There are different factors affecting the performance of individual publicly-traded companies and the overall performance of the market. Consider the relationship between interest rates and stock prices or macroeconomic phenomena such as economic downturns and full-blown economic crises as examples.
However, investing in the stock market has notable advantages compared to other asset classes and securities. A look into historical data would show that few assets and securities can match the returns generated by stocks. This article explores and explains the advantages and disadvantages of stock marketing investing.
Advantages of Stock Market Investing: Notable Characteristics of Stocks and Benefits of Stocks Investing
1. Solution for Beating Inflation in the Long-Term
There are several factors that influence inflation rates but the fact remains that inflation is inevitable even in well-functioning economies. The reality today is that the value of money today will not be the same in the future due to the increasing prices of products.
Furthermore, retaining cash assets or keeping money in bank deposits and other bank-related products such as time deposits is the best way to lose wealth. The same is true when it comes to investing in assets and securities with low risk and low returns.
The realities about inflation essentially mean that saving money in the bank or venturing into low-return investments is not a good option for achieving long-term financial goals such as building retirement funds or preparing for the education of children.
Nevertheless, beating inflation means investing money in assets and securities with the potential to grow ahead of inflation rates. Stock market investing is the most feasible solution for staying ahead of inflation and building passive wealth in the long term.
Inflation rate in the United States averaged 1.5 percent from 1990 to 2021. There were years were inflation rate was above 3 percent. In comparison, the 10-year annualized return for S&P 500 was 14.43 percent as of 31 January 2022.
2. Maximizing the Advantage of a Growing Economy
Another advantage of stock market investing is that it can mirror the growth of an economy. Remember that the performance of publicly-traded companies and their individual stocks are also influenced by several macroeconomic factors.
Economic growth can also be an indicator of good stock market performance. A booming economy means that production and consumption activities booming. This can also indicate that companies listed on stock exchanges are earning well.
Both the economy and the stock market have a linear economy. Investing in the stock market or entering the market at the most appropriate time can mean experiencing the benefits of a flourishing economy and taking advantage of economic gains.
The aforesaid explanation also means that the benefits of investing in the stock market can be achieved by looking for companies or stocks operating in emerging markets and developed countries, as well as in emerging and established industries and sectors.
3. Ease and Security of Stock Market Investing
Participating in the stock market is also relatively easy. Even beginners or individuals with no background in finance and investing can readily purchase stocks or participated in pooled equity funds through different agencies and means.
For example, direct stock investing can be done at home through online stock brokerages and trading platforms. Individuals and institutions can also invest indirectly through asset managers and select through different types and selections of pooled funds.
Direct investing and indirect investing have their respective advantages and disadvantages. However, doing both can help in maximizing the benefits of each and reducing their individual risks and drawbacks, as well as in creating a diversified portfolio.
Affordability is another advantage of stock market investing. An individual investor does not need a lot of money to start investing in stocks. Pooled funds offered by asset management companies have minimal upfronts some do not charge commission fees.
There are also government regulatory bodies that regulate and oversee the stock market and companies listed on stock exchanges. In the United States, the Securities and Exchange Commission regulates different American-based stocks.
4. Potential to Generate Wealth and High Liquidity
Investors can earn from stocks in two ways: either by purchasing stocks that pay dividends or through price appreciation. Remember that owning stocks or shares of a company represents ownership. Owners benefit from the profitability of a company.
Another way to earn from the stock market is through trading. Note that there is a difference between trading and investing. The purpose of trading is to earn money on a more frequent basis. Traders fundamentally buy and sell assets within a short period.
This period can last for a week or months. Some periods can be as short as 24 hours, such as in the case of day trading. Traders generate profit through asset appreciation. They take note of highs and lows in the market to make enter and exit positions.
Another advantage of stock market investing is the high liquidity of stocks. Of course, bank deposits are the most liquid asset in the entire financial market. But stocks are readily sellable due to the high volume of transactions in the stock market.
Note that assets such as real estate, commodities such as precious metals, and material possessions such as artworks are relatively harder to sell and liquidate. Other assets that have high liquidity are cryptocurrencies or crypto-coins and crypto-tokens.
4. Options for Portfolio Diversification and Risk Management
Stocks are generally high-risk and a high-return class of assets. There are different factors affecting the value of a particular stock or the performance of the stock market. Owning stocks is still one of the best ways to create and maintain a diversified portfolio.
Furthermore, it is important to note that there are different companies operating in different industries and sectors that have different levels of sensitivity to market-related factors. This translates to diversification within a stock portfolio.
There are so-called growth stocks that generate positive and sustainable cash flow. Some examples of growth stocks based on historical data are the stocks in popular tech companies such as Apple, Amazon, and Netflix, among others.
So-called defensive stocks provide consistent dividends and stable earnings regardless of the state of the stock market and other macroeconomic fundamentals. Examples include stocks in essential companies such as electricity, oil and gas, and water.
Disadvantages of Stock Market Investing: Challenges, Limitations, and Drawbacks of Investing in Stocks
1. May Require Expertise and Takes Time to Research
Investing can be considered a gamble because returns are not always absolute. One of the disadvantages of stock market investing is that it requires expertise. Stock investors should also take time to research and remain aware of relevant events.
A particular investor must have basic knowledge on how to enter the stock market. He or she must also decide whether pursue direct stock investing or indirection investing. One can do both direct and indirect investing but he or she must decide on allocation.
Trading requires specific skills. Traders can choose between two analytical tools or both. These are fundamental analysis and technical analyses. These tools can help them decide when to buy and sell or make enter and exit positions.
It is also important for investors to research a particular company before buying stocks from it. In addition, they also need to become familiar with what is going on in that particular company and how current events are affecting its performance and profitability.
Some investors and traders hire financial advisors to give them expert guidance in their decisions. However, this means additional cost. Those who choose indirect investing can take advantage of the expertise of their fund managers.
2. Risks Due to Market Volatility and Uncertainties
Another disadvantage of stock market investing is risk. Remember that the market can be volatile because it is sensitive to current events and other developments affecting not only the economy but also national and international political affairs.
Several stocks are affected by the prices of oil and gas in the global market because involved companies depend on energy inputs in their manufacturing and transportation or distribution activities. The Ukraine-Russia conflict is a notable example.
Other stocks are also sensitive to interest rates or the performance of bonds. There is an inverse relationship between stocks and interest rates and the bonds market. Of course, note that some stocks are unaffected by oil and gas prices, interest rates, and bonds.
Economic crises also involve stock market crashes. These events have been observed during the 2008 Financial Crisis that started in the United States and the European Debt Crisis that transpired in the European Union and affected other countries.
The COVID-19 pandemic also demonstrated the susceptibility of the market to widescale disruptions in economic activities. Other examples of localized problems are Brexit and the Evergrande Debt Crisis that saw downward price trends in several stocks.
3. Intense Competition, Speculation, and Emotions
Other disadvantages of stock market investing are the intensity of competition with institutional and professional investors, the propensity of several investors to speculate, and the highs and lows of individual emotional states that affect investment decisions.
An individual stocks investor who is either a beginner or has no access to expert advice and relevant resources is at a disadvantage when compared with institutional and professional investors who have time and knowledge to make wise decisions.
These institutional and professional investors also have access to sophisticated analytical and trading tools. Some use proprietary computer software to predict the market. Others have knowledge in using financial models and access to market research.
Speculation is another drawback of investing in the stock market. Note that market speculation has pros and cons. Some of its notable disadvantages include momentary dips or surges in stock prices that can leave other investors in a panic.
Panic can result in massive dumping that can devalue a particular stock or negatively affect the performance of the entire stock market. Some investors are prone to making investment decisions based on emotions rather than logic.
A Note on the Advantages and Disadvantages of Stock Market Investing: Appreciating Its benefits and Accepting Its Risks
Remember that there is a mere handful of assets and securities that match the performance of the stock market and its profit-generating benefits. A key advantage of stock market investing is that it has the potential to beat inflation by producing double-digit returns on investment when done through strategic trading or long-term buy-and-hold strategies.
However, the fact remains that risk is the core disadvantage of investing in the stock market. Of course, it provides higher returns versus assets and securities such as bank deposits and bonds. It is also highly liquid than real estate and commodities. It is important to highlight that high-return assets and securities almost always have high risks.