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 be investing in stocks." That's actually true, but there's more to it than that. There are both upsides and downsides to investing in stocks, and depending on your information sources, you may be hearing too much of one side and not enough of the other.

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

Image source: Getty Images.

The upsides of investing in stocks

Let's start with reasons why stock market investing is a sensible choice for many, if not most, investors.

You can build massive wealth

You really can amass great wealth with stocks -- because over long periods, the stock market has averaged annual gains of close to 10%. Check out the table below for some eye-popping examples using a more conservative 8% annual gain:

Calculations by author.

You don't need to be a genius

Another plus for investing in stocks is that you don't need a degree in finance to do it successfully. You could spend a lot of time becoming a stock market expert and superb stock analyst, but you can instead just opt for easy, low-fee, broad-market index funds, such as those that track the S&P 500. Doing so will get you roughly the same returns as the overall stock market, and you might be able to match the growth in the table above.

There are stocks to suit all of us

Another upside of stocks is that there are lots of different kinds of stocks, tied to many different kinds of companies. It's not recommended, but if you want to park your money solely in exciting new, small companies, you can. If you prefer large, established dividend payers, there are plenty of those companies, too. You can also focus on a wide range of industries, from financial businesses to software specialists to energy companies. Overall, it's best to diversify across a range 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 loaded in order to get wealthier via stocks. You can start by just saving up whatever you can over some months, and then invest in a few shares of stock -- or a few shares of an index exchange-traded fund (ETF), such as the SPDR S&P 500 ETF (SPY). Keep doing so over time, and increase the size of your investments as you're able to, and, ideally, you should see your assets grow. If your resources are very meager right now, look into buying fractions of shares.

You can access your money quickly

Liquidity is another plus for stocks. With some investments, such as real estate, you can't just withdraw some or all of your value from them immediately or in short order. You'd have to list and sell a house, which can take weeks or longer, or you might apply for a loan with the real estate as collateral. With stocks, though, the market is open every weekday, and you can buy and sell stocks then. It's worth noting, though, that just because you can sell shares quickly doesn't mean you should. After all, a stock may have crashed temporarily right before you sell shares, meaning that you left some money on the table. (More on this soon, among the downsides of stocks.)

You can stay ahead of inflation

Finally, investing in stocks can help you stay ahead of inflation and grow your assets. Over many decades, inflation has averaged close to 3%, annually, though there have been periods when it has been much higher or lower. Stocks (as represented by the S&P 500), meanwhile, 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 return of less than 3%, you're losing ground in your wealth-building attempts. You're taking one step forward and one or two steps back.

Image source: Getty Images.

The downsides of investing in stocks

Of course, investing in stocks isn't perfect for every person in every situation. Here are some cautions to keep in mind.

Returns are not guaranteed

For starters, while stocks tend to outperform lots of alternative investments over long periods, they may not do well over your particular investing period. The table below reflects the research of Wharton Business School professor Jeremy Siegel, who calculated the average returns for stocks, bonds, bills, gold, and the dollar from 1802 to 2012:

Source: Stocks for the Long Run.

The longer your investing time frame, the more time you'll give investments to recover from downturns.

It takes time

That brings us to the next caution: If you want to grow wealthy via stocks, you can do so, but it generally takes decades, not weeks or months. Revisit the table up top, and you'll see the power of time and compounded growth. Your money might be growing by tens of thousands of dollars annually after a few years, but it can be growing by hundreds of thousands of dollars annually, on average, over decades. You need to be patient to be a great investor.

The stock market is volatile

Understand, too, that the stock market is volatile. Over time it has always gone up, but not in a straight line. There are plenty of corrections and crashes along the way, and you need the fortitude to not freak out and sell in a panic when they happen. Check out the table below to see just how much returns can vary from year to year:

Source: YCharts.com. 

The market's volatility is why you should only invest dollars 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 holding has just crashed.

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

Another downside of investing in stocks is that you can lose much, or even all, of your money if you don't know what you're doing. There are lots of ways to lose money in stocks, and lots of common investing mistakes you might make. Here are just a few:

• Not paying off high-interest-rate debt before starting to invest
• Buying investments you don't understand, such as options or commodities
• Speculating on high-flying stocks and penny stocks
• Buying stocks on margin, with borrowed money
• Trying to time the market
• Day-trading

You will lose some money -- even if you do know what you're doing

Given the volatile nature of the market, the fact that we all make mistakes, and the fact that even well-researched investments will sometimes not work out as planned, you can count on losing some money now and then. Be prepared for that, or just don't invest in stocks. You can get guaranteed gains from savings accounts and certificates of investment and other less risky investments, but they're not likely to grow very quickly, and not having your money grow as needed is also kind of risky.

What should you do?

So what should you do? Well, definitely consider investing in stocks with your long-term money. It's hard to beat the growth potential of stocks. But don't do so blindly. Read up on stock market investing, so that you're comfortable with what you're doing.

Consider just sticking with index funds, too, if you don't want to commit the time and effort to become a good evaluator of companies and stocks. There's no shame in that, and you'll likely outperform many managed mutual funds. If you want to invest in individual stocks, though, read a lot, and then keep reading and learning for the rest of your investing life.