Table of Contents: The Power of Stocks
Many people think the power of stocks is only for the wealthy, but that’s not true. Anyone can invest in stocks and make a killing. In this blog post, I will show you how it’s done. Investing in stocks has been one of the best ways to generate wealth. While many people have become well-off and reached financial freedom by investing, it is still unclear to some why they should put their money in the market and unlock the power of stocks.
Well, to understand that, I will introduce to you some of the benefits of parking your money in stocks and some of the drawbacks of doing so. However, before we continue, full disclosure, this is by no means financial advice. My job is to simply provide you with information and knowledge while entertaining you at the same time. What you will do with that information is entirely your personal choice. With that being said, and without further ado, let’s jump into the pros and cons of investing in the stock market.
Benefits of Investing in the Power of Stocks
Well, the first and most obvious reason why we invest is to make money. And the power of stocks has been one of the best investment vehicles that lead many to find wealth.
On average, the stock market return has been about 10% yearly since 1926 in the U.S. To those who think that’s not impressive, well, you’re right. 10% is not a figure to brag about. But, comparing it to the yield (also known as earnings that you receive) from other investments, 10% looks attractive.
For example, investing in a safe position like U.S. government bonds have yielded a 5% to 6% return since 1926, which is about half the return of stocks. Others choose to put their cash in a savings account to earn interest. While that might seem like a responsible financial choice, savings accounts only offer 0.2% interest on average.
Hedge Against Inflation
Stocks can also help you protect your wealth against inflation. There is a misconception that you’re making money as long as you earn interest on your investments. Well, that claim completely leaves inflation out of the equation.
Simply put, if the percentage return you can get is less than the inflation rate, you are actually losing money. Remember, inflation means your money is becoming less valuable over time.
So, since 1913 the long-term inflation averaged about 3.1% every year, which is way below the 10% return we could get from the power of stocks. This is especially important when the inflation rate in the U.S. is currently 7.7%, the highest level in four decades. With that kind of erosion of purchasing power, a 5% return from government bonds or the meager yield of 0.2% from savings accounts certainly will not be enough.
Generate Passive Income
Many think that the only way to make money from stocks is by selling shares of companies at a higher price. While the potential of earning significant profits from selling is the most enticing aspect of the power of stocks, investors can also generate a passive income source with stock dividends.
You see, when a company makes profits from its operations, the executive team can decide to either reinvest those profits back into the firm, or distribute them to shareholders in the form of dividends.
Dividends are the money you receive based on the number of shares you own in a particular company. This money is typically distributed to stockholders quarterly, but some firms do it monthly. Also, dividends are usually paid out from high-quality businesses with solid revenues, such as AT&T, Microsoft, Apple, and Target.
With a predictable source of income, dividends are a popular way for someone at a retirement age to take advantage of. But if you are still young, then the best practice is to reinvest those dividends back into the market, further earning you a higher return.
When learning about the investment world, you will often stumble upon the word “liquidity.” Liquidity refers to how easily an asset can be converted into cash. If an asset can be sold quickly, we call it liquid; if not, we call it illiquid.
For example, you can buy and sell stocks anytime during the open market hours on any given day, making them a liquid investment. On the other hand, assets like real estate are very illiquid. This is because you can’t just buy a house today and then sell it tomorrow. A house can stay on the market for months or years before finding a buyer.
The benefit of a liquid investment is that you can raise money when you need it the most, such as in emergency cases. As long as you buy stocks from your brokerage account, you can sell them at your discretion.
Next, one important concept to keep in mind when you make any kind of investment is “diversification.” A diversified stock portfolio means you own different stocks. The reason to diversify is to minimize the risk in the market.
Putting your money into stocks is not without risks. The stock market can be very volatile at times. So, you might never know if the company you invest in will suddenly go bust. If a business is failing or, worse, going bankrupt, you can expect to see its stock price plummet to nothing. Always diversify your stock holdings to avoid having your portfolio wiped out from an extreme crash like that.
One cool thing about diversification is that not only can you pick different stocks, but you can also choose companies from various industries. Selecting many diverse sectors in your portfolio, from semiconductor businesses to automakers, can ensure that you won’t lose too much money in the worse economic environment.
The Ability to Start at Any Amount
Some people misunderstand that you have to have a lot of initial money to invest; therefore, stock investing is only for wealthy individuals. Well, I’m here to tell you that’s not true at all.
Buying and selling stocks used to come with commission fees. But since then, many brokers have offered trading with zero commissions. This makes owning shares of companies more affordable for new investors.
Another beneficial concept that you should know of is called fractional shares. Instead of paying for the price of one entire share, you can now pay for a portion or a fraction of that share. This removes the barrier of investing your money, as you can now begin to invest with any amount.
For example, Berkshire Hathaway, an investing company founded by the legendary investor Warren Buffet, has a price of about $468,000 per share. Hardly every investor can invest that much for their entire portfolio, let alone just one stock. However, with fractional share buying, you can spend $100 or even $10 to buy the company stock, even though you would only own 0.02% of a Berkshire share.
Drawbacks of Investing in the Power of Stocks
Now that you understand some of the advantages and benefits that investing provides, you should also be aware of all the drawbacks that come with it.
The stock market can be volatile
Despite the great long-term reward stocks bring to investors, the market is fickle by nature. While most of the time, you can expect share prices to go up, many people can see their stock investments evaporate under economic stresses.
To explain my point, let’s look at stock returns during times when the economy was performing poorly. During the Dot-com bubble in the year 2000, the market fell 49.1% in the U.S. Fast forward to the Great Recession, and the stock market dropped 56.8% in 2007. And finally, when the Covid-19 pandemic hit the world, the stocks nosedived by 33.9% on March 2020.
Combining those three periods, you would have lost an average of 46% of your stock portfolio. Based on the historical average, those declines tend to happen once per decade.
Other reasons why you should not invest
Investing should not always be your first priority. Paying off debts and covering personal expenses should be prioritized instead.
Experts recommend staying invested in stocks for at least 5 to 10 years. This ensures that the company has time to grow and the stock price has time to appreciate. You should not park your cash in stocks if you anticipate needing money within the next 3 to 5 years for large expenditures like a house down payment or buying a car.
Also, if you have not established an emergency fund that can last at least six months, you should commit to that first. There is always a good company for you to invest in. Still, suppose you are unprepared for a financial situation; you might not be able to recover.
If you have high-interest debt, pay it off as soon as possible before investing. Obligations like credit card interest payments are unforgiving. A credit card interest rate can go as high as 20% annually, double the stock market average return. It would do you well if you focused on clearing all your debts first.
There you have it, folks. Those are the pros and cons of investing in the stock market and the power of stocks. While the cons might scare some of you off, if you don’t have any other purpose for your money and you’re willing to hold a stock position for the long term, I believe the power of stocks outweighs all of the drawbacks.