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It’s no secret that you can make serious money through the stock market. Stocks are a very lucrative investment if managed properly.
However, for it to be lucrative, you need a proper investment plan, and to create a proper investment plan, you need to understand the pros and cons.
That’s why in today’s post, I’m going over the pros and cons of stocks.
By the end of this article, you’ll walk away (or click away) knowing exactly what the pros and cons of the stock market are, and how you can implement this information into your investing strategy.
Without further ado, let’s get started.
The Pros of Investing in Stocks
Let’s start by taking a look at the pros of stocks.
Profit as the Economy Grows
The stock market is generally in tandem with the economy. If everything in the economy is looking good, the stock market rises, and if the economy goes through a recession, the market falls.
This is because the stock market is often correlated with the nation’s GDP or gross domestic product.
The GDP is a measurement of how much money is in circulation in the economy. This includes consumer and business spending, exports, and government spending.
More money being spent often implies people have money to spend in the first place. As corporate earnings rise, more companies experience growth and hire more employees. Therefore, more jobs become available, and people have more money to spend due to the plethora of jobs.
As you can imagine, when things are looking up for the economy, the stock market rises. Investing in the stock market is a great way for your money to experience this growth as well.
Beat Inflation
Investing your money in the stock market is a great way to outpace inflation.
I’m sure you’ve noticed how prices are always going up on everything.
But did you know that the annual rate of inflation ever since the 1960s is around 3.8%? In other words, every year you’re losing 3.8% of purchasing power on your money.
The stock market averages around 9% per year. If we do the math and subtract 3.8 from 9, this gives you a gain of 5.2%.
By investing in the stock market, you can outpace inflation by 5.2%.
Easy to Buy, Sell, and Manage
Don’t we all enjoy a day at home doing nothing every once in a while? Sometimes all we need in our hectic lives is some time to just chill and do nothing.
Luckily for us, our stock investments can be managed from home. As long as you have an internet connection, and a computer or smartphone, you can manage all your stock investments from the comfort of your bed.
A lot of this is thanks to the internet.
Before the internet, you had to call your broker to maintain your stock investments. You also had to pay a commission every time you placed a buy or sell transaction.
Now, you can save so much time and money because everything is accessible online. Buying and selling stocks cost nothing, as many U.S. brokerages have eliminated commissions.
Stocks are also a much more stay-at-home investment compared to real estate. Generally, with real estate, you would always have to be up and about from managing and maintaining physical properties.
Stocks are what they call “financial assets,” which are assets that cannot be seen or touched, but contain a monetary value.
Little Startup Capital Required
Investments like real estate require a lot of funds upfront. Not only do you need the initial capital for down payments, but if you’re like the majority of us, you probably need to get a loan from the bank as well.
Loans aren’t free, and you’ll likely end up paying a lot of interest to the bank.
With stocks, you won’t have to worry about going through that hassle, because there is no barrier or minimum capital requirement to invest.
Back in the day, commissions and the cost of one share being too high could’ve been potential barriers to the stock market. But these days, a lot of brokers offer $0 commissions and fractional shares.
Because of this, you can start investing in stocks with as little as $1!
Fidelity is a great brokerage to invest with. They offer fractional share investing and have no minimum initial investment requirement for their index funds.
Vanguard is also another great brokerage. They offer fractional shares on Vanguard ETFs, but their index funds have high minimum initial investment requirements that range from $1,000 to $3,000.
High Return on Investment
The average annual return for the S&P 500 has been around 9%. That’s a much higher yield than other investments such as bonds and certificates of deposit.
For example, take a look at how a 100% stock portfolio would compare to a 100% bond portfolio below.
If you invested $10,000 in the stock market and another $10,000 in bonds back in the 1980s, here’s what you would have in 2022:
- $333,700 from the stock market
- $60,426 from bonds
Stocks gained more than five times the value of bonds.
The Cons of Investing in Stocks
Now that we’ve covered the pros, it’s time to cover the cons of stocks.
Takes Time to Build Wealth
I’m sure you’ve seen a whole bunch of YouTube gurus saying you can get rich quickly by trading stocks. But the majority of those people are what I call fake gurus, and they make money by selling courses, not by trading stocks.
Getting rich through stock market investing is a long-term goal. As a matter of fact, the more time you have, the better, and the reason is the compounding effect.
The compounding effect is like a snowball rolling downhill, getting larger and larger the more it rolls.
When you invest your money, your money will earn its share of returns. Those returns would then earn more returns, and those additional returns would earn more. See how your returns would compound exponentially?
The only catch is compounding takes time and requires patience. It’s like a snowball rolling downhill, only the snowball rolls slowly. Take a look at the visual below.
The man who started investing at 25 only has to invest half as much to reach $1,304,471.51, while the other who didn’t start until he turned 40 has to invest twice as much and only accumulates $613,525.85.
This is because the younger person has much more time on his side. He has time to allow his investments to compound.
Volatility
As I mentioned earlier, stocks yield a high return on investment. But like with any investment, high yield comes with high risk. The more potential an investment has to earn, the more risk it comes with.
Let’s take a look at the same chart we did earlier.
If we look at the orange line that represents the return for bonds, it’s a much smoother line. Yes, bonds yield less, but also come with less risk.
Compare that to the blue line that represents the return for stocks. Can you see how volatile it is, especially at the black arrows?
Stocks are a much more volatile investment compared to bonds. Bonds pay out stable interest at the end of each month, but the yield for stocks cannot be predicted in the short term.
If you want to invest in stocks, you’re going to have to stomach a lot of volatility.
No Short-term Guaranteed Return
Investments like bonds, savings accounts, and certificates of deposit have guaranteed rates of return.
If you go to the website of any bank or brokerage that provides investments such as bonds, savings accounts, and CDs, you’ll see that they clearly state the APY or annual percentage yield.
Although this APY is subject to change depending on the FED’s interest rate, you get a clear picture of how much money the investment is going to yield.
The same is not true for stocks. Although we can look at the historical performance of the stock market, there are no guaranteed returns for the future.
We can only make a smart guess as to what the stock market will yield in the future, by looking at how it performed in the past.
Businesses Go Bankrupt
No matter how successful a business may be, unfortunate things happen. Sometimes companies go out of business and end up filing for bankruptcy.
Shareholders are the last ones in line to get paid when a company files for bankruptcy. This means that if the company you have shares in goes bankrupt, there’s a high chance you’re not getting your money back.
A study conducted by Jeremy J. Siegel et al. states that every year, around 20 companies get added to the S&P 500 and 20 are dropped.
That tells us how many companies are being replaced by new ones, and gives us an idea of how companies can easily go under.
How To Tackle The Cons
So now that you know all the pros and cons of stocks, how do you make sense of all this information?
It’s pretty simple: spend less than you earn, invest in low-cost index funds, and don’t panic sell.
This is what I always teach my readers here on InvestaMind.
Spend Less Than You Earn
Unfortunately, money doesn’t grow on trees, and you need money to invest in the stock market. That money is going to have to come from somewhere.
If you’re living paycheck to paycheck, you must find a way to either increase your income or decrease your expenses. Those are the only two methods that’ll allow you to have money left over at the end of each month.
I also have an in-depth post on how to save money on a low income.
Invest in Low-cost Index Funds
An index fund is like a basket full of different stocks. By investing in an index fund, you gain diversification of many different stocks across different sectors.
Instead of picking stocks yourself and risking them going bankrupt, an index fund will almost completely eliminate that risk.
Don’t know where to get started? Check out my post on the 3-Fund Portfolio. It’s an investment strategy that only involves three different index funds. Super simple and anyone can be successful with it.
Don’t Panic Sell
After you get all your investments set up, you’re going to want to stay on pace and keep investing like you originally planned.
Panic selling not only disrupts the “compounding effect” I talked about earlier, but it also subtracts the amount of time you’ll be in the market.
Keep investing no matter what the stock market does – which includes it dropping 20%, 30%, or even 40%.
Think about it like this.
Let’s say you wanted to buy a pair of shoes and the store suddenly announces a big sale. The shoes you’ve always wanted go on a 30% sale. Would you still buy it? Of course.
The quality of the shoes didn’t change, only the price, and it’s cheaper.
On the other hand, let’s say the store raised the price by 30%. Would you still buy it? Maybe not. You’d probably look elsewhere.
Why is it that we do the opposite when it comes to the stock market? When stocks go up, people buy in at expensive prices, hoping to catch some profits, but when stocks go down, they sell in a panic.
It’s because those people don’t understand that stocks are businesses, and they don’t understand the businesses they’re buying.
Buy stocks like you’re buying groceries. If the underlying business remains the same, you should get excited when the stock market goes down – you’re getting a discount.
Conclusion
To sum up, the points we’ve spoken about today…
The pros of stocks are:
- Profit as the economy grows
- Beat inflation
- Easy to buy, sell, and manage
- Little startup capital required
- High return on investment
The cons of stocks are:
- Takes time to build wealth
- Volatility
- No short-term guaranteed return
- Businesses go bankrupt
The pros of investing in stocks definitely outweigh the cons, especially when you know how to work around the cons (which you now know).
How many stocks are you invested in?