The pros and cons of investing in stocks

You may have been told something like, “If you want to make a lot of money, you should invest in stocks.” That is really true, but there is more to it than that. Investing in stocks has advantages and disadvantages, and depending on your information sources, you may hear too much on one side and not enough on the other.

Here’s a quick look at whether you might want to invest in stocks.

Image source: Getty Images.

The advantages of investing in stocks

Let’s start with the reasons why investing in the stock market is a sensible option for many, if not most, investors.

You can build massive wealth

You can really accumulate great wealth with stocks, because for long periods, the stock market has averaged close to 10% annual earnings. Check out the table below for some amazing examples using a more conservative 8% annual profit:

Source: Calculations by author.

You don’t need to be a genius

Another advantage to investing in stocks is that you don’t need a finance degree to do it successfully. Your could Spend a lot of time becoming a stock market expert and an excellent stock analyst, but instead you can go for easy, low-rate, broad-market index funds like the ones the S&P 500 tracks. Doing so will give you roughly the same returns as the general stock market, and you may be able to match growth in the table above.

There are actions for all of us

Another advantage of stocks is that there are many different types of stocks, linked to many different types of companies. It is not recommended, but if you want to park your money only in small and exciting new companies, you can. If you prefer large established dividend payers, there are plenty of such companies, too. You can also focus on a wide range of industries, from financial business to software specialists and energy companies. In general, it is better to diversify into a variety of companies and industries, to avoid having too many eggs in one basket.

You can start with very little money

You also don’t need to be charged to get richer through stocks. You can start simply by saving what you can for a few months, and then invest in some stocks, or some stocks in a publicly traded fund (ETF), such as the SPDR S&P 500 ETF (TO SPY). Keep doing it over time and increase the size of your investments as you can, and ideally, you should see your assets grow. If your resources are very scarce right now, consider buying fractions of stocks.

You can access your money quickly

Liquidity is another advantage for stocks. With some investments, such as real estate, you cannot simply withdraw some or all of its value from them immediately or in the short term. You would have to list and sell a house, which can take weeks or more, or you can apply for a loan with the property as collateral. However, with stocks, the market is open every day of the week, and you can buy and sell stocks at that time. However, it is worth noting that just because you can Selling shares quickly doesn’t mean you should. After all, a stock may have temporarily fallen just before selling stock, which means it left some money on the table. (More on this soon, among the disadvantages of stocks.)

You can get ahead of inflation

Finally, investing in stocks can help you stay ahead of inflation and grow your assets. For many decades, inflation has averaged close to 3%, annually, although there have been periods when it has been much higher or lower. Shares, meanwhile (represented by the S&P 500) have averaged close to 10%, allowing investors to easily avoid losing purchasing power. If you invested in bonds or savings accounts or other things that offer a yield of less than 3%, you are losing ground in your attempts to create wealth. You’re taking one step forward and one or two steps back.

Image source: Getty Images.

The disadvantages of investing in stocks

Of course, investing in stocks is not perfect for all people in all situations. Here are some precautions to keep in mind.

Returns are not guaranteed.

For starters, while stocks tend to outperform many alternative investments over long periods, they may not perform well during your particular investment period. The following table reflects the research of Wharton Business School professor Jeremy Siegel, who calculated the average performance of stocks, bonds, bills, gold and the dollar from 1802 to 2012:

Source: Long-term stocks.

The longer the investment time, the more time you will invest to recover from recessions.

Take time

That brings us to the next precaution: If you want to get rich through action, you can, but it usually takes decades, not weeks or months. Go back to the table above and you will see the power of time and compound growth. Your money may be growing by tens of thousands of dollars a year after a few years, but it may be growing by hundreds of thousands of dollars a year, on average, for decades. You need to be patient to be a great investor.

The stock market is volatile.

Also understand that the stock market is volatile. Over time it has always gone up, but not in a straight line. There are many fixes and glitches along the way, and you need the strength not to panic and panic when they happen. Please refer to the table below to see how much returns may vary from year to year:

Source: YCharts.com

Market volatility is the reason you should only invest dollars that you won’t need for five, if not 10, years in stocks. You don’t want to have to sell when the market or your share has fallen.

You can lose your shirt if you don’t know what you’re doing

Another disadvantage of investing in stocks is that you can lose a lot or even all of your money if you don’t know what you are doing. There are many ways to lose money on stocks and many common investment mistakes you could make. These are just a few:

• Failure to pay high interest rate debt before investing
• Buy investments you don’t understand, such as options or commodities
• Speculating on high-flying stocks and pennies
• Buy shares on the sidelines, with borrowed money
• Trying to time the market
• Changeover day

You will lose some money, even if you know what you are doing.

Given the volatile nature of the market, the fact that we all make mistakes, and the fact that even well-researched investments sometimes won’t work as planned, you can count on losing some money from time to time. Be prepared for that, or just don’t invest in stocks. You can make guaranteed profits from savings accounts and investment certificates and other less risky investments, but they are not likely to grow very fast, and not making your money grow as needed is also a bit risky.

What should you do

So what should I do? Well, definitely consider investing in stocks with your money in the long run. It is difficult to overcome the growth potential of the shares. But don’t do it blindly. Read about investing in the stock market, so you are comfortable with what you are doing.

Also consider sticking with index funds, if you don’t want to commit the time and effort to become a good stock and business evaluator. There is no shame in that, and you will probably outperform many managed mutual funds. However, if you want to invest in individual stocks, read a lotAnd then keep reading and learning for the rest of your investment life.