Pros and Cons of Investing in Stocks

Investing in stocks is an essential part of growing a store of wealth. Your assets will help fund your lifestyle after retirement, make a down payment on a property or educate your children. 

Stock portfolios carry some risks as prices are prone to fluctuation, but over time stock markets have proven resilient and can help beat inflation. You’ll also pay less tax on investment income, so investing in stocks makes financial sense.

This article looks at the risks and rewards of investing in stocks and how stock trades can affect your portfolio.

Risks Involved with Stocks

Investing in stocks comes with risks. It comes with the territory – usually the higher the reward, the higher the risk you have to take on. Savvy investors manage these risks through portfolio diversification. Unless you take some risks in your investment decisions, it is unlikely that your accumulated wealth will keep pace with inflation. A stock portfolio is fundamental to a medium to long-term financial strategy.   

Market Risk

Market risk, also known as systemic risk, is the risk you may lose money because of economic, political or other events that affect the market in general. The three types of market risk are:

• Equity risk: The risk that share prices drop in response to supply and demand or market expectations.
• Currency risk: If you have foreign shares, an unfavorable change in currency value will reduce the value of your investment.
• Interest rate risk: Interest rate movements can affect market performance as interest rates affect the cost of servicing debt. Most companies rely on borrowed money for growth and expansion, so when interest rates rise, firms have higher liabilities. They will also be more reluctant to borrow money for investment. The combination of higher liabilities and slower growth can harm the value of stocks.

Concentration Risk

Concentration risk is the risk you run if you place too much of your income in one type of investment. Diversifying your portfolio spreads the risk over multiple assets so that your money isn’t overexposed to a single industry or sector.  

Inflation Risk

When prices go up, production input costs also rise. More often than not, high inflation is also accompanied by rising interest rates as central banks strive to control inflation. High inflation can be destructive and lead to damaging recessions. Investing in stocks is still the best way to protect the value of your savings because history shows that, over time, stock values outstrip the effects of inflation. 

Volatility Risk

Investors often face unpredictable price movements. Share values that move quickly and by a significant amount are considered volatile. If you have invested a large amount in these shares, you risk substantial loss.  

Liquidity Risk

Liquidity measures how easy it is to buy and sell an investment. If you’ve invested in stocks for which there are few buyers, you may not be able to sell your stocks when you need to. You may also move market prices if you are trying to trade a stock in larger sizes than liquidity allows. 

Rewards of Investing in Stocks

You can find many good reasons why you should start investing in stocks sooner rather than later. Some of the rewards you can look for from your investment in the stock market are listed here.

Better Long-Term Returns

Though stocks move up and down, they should increase in value over time. Stocks are one of the best inflation hedges investors will find, as they will generally outstrip inflation. On average, the stock market has returned 10% since 1926. This return is considerably higher than returns on government bonds or fixed deposits.  As a shareholder, you can sell your stocks whenever you want to, so you can sell when the share price looks good. 

Dividend Income

Dividend income can serve as a tax-efficient income source. You can also reinvest your dividends and buy additional shares to increase your wealth. The value of dividends compounds over time so that your dividends grow dividends and your assets grow at a faster rate.

Liquidity

Stocks are typically easier to sell than other assets like property, jewelry or art. Most stocks trade publicly on a stock exchange and can be bought and sold on an exchange. This liquidity means that if you need to buy or sell a position, you usually can.

Tax Benefits

Taxation rates on capital gains and dividends are typically lower than taxes on employment income. If your investment is part of your retirement saving, as part of your IRA, you won’t have to pay tax on the income when you earn it. You could choose, instead, to pay the tax when you withdraw after retirement. 

Diversification

Stocks offer you an easy way to diversify your investment portfolio, which may include cryptocurrencies, property and bonds. Diversification will help you enhance your risk profile and optimize profits. You could also start small with fractional shares and grow your investment over time.

Who Should Invest in Stocks?

Everybody needs a store of wealth, so anyone can benefit from an investment in stocks over the medium to long term. Such investments are best for: 

• Retirement investors: Though there are stock market investors who can make a profit on stocks over the short-term, long-term investors generally ride out ups and downs on the stock market, growing their wealth over time. Opening a retirement account early on can help prepare you for financial success in the future.
• Parents: An education has gotten notoriously expensive and the cost of college is only expected to grow. Many parents invest in stocks to build assets from which to fund their children’s college education.
• Young people: For young people with minimal funds, investing in the stock market may seem like a pipe dream, but you don’t need much money to get started. The time will come when you want to make a down payment for the mortgage on a new home, buy a car or take a dream holiday abroad. It is better to benefit from the compound interest earned on your investment in stocks than borrowing money for those big purchases and paying interest.

Invest in Stocks with Benzinga's Top Online Brokers

Whether you’re new to the stock market or a seasoned investor, you may wonder what stocks to buy as you start your investment journey. Benzinga compares the best stocks by sector and online stock brokers in one place, making it easy to choose. 

Open Your Brokerage Account and Invest in Stocks Today

Investing in stocks is an investment vehicle with its own risks and rewards. Investing in stocks can provide long-term growth potential with the right approach and patience. However, stock investments also carry high levels of risk that should be carefully weighed before taking the plunge.

Ultimately, investing in stocks requires a thorough understanding of financial markets and a willingness to take risks. It is important to do your own research, carefully weigh the pros and cons of investing in stocks, create an investing strategy and make sure you are comfortable with the level of risk before committing your hard-earned money.

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