The stock market has created enormous wealth over the years. On average, the S&P 500, which includes 500 of the largest U.S. publicly traded companies, has returned 8% to 12% annually before adjusting for inflation. At an 8% annualized return, $10,000 invested in the stock market 50 years ago would have grown to almost $460,000 today.
However, be aware that the stock market doesn't go up every year. The S&P 500 typically falls three out of every 10 years. Some drops can feel quite brutal, and the market's level of volatility is not for everyone. But if you can manage your fear, stocks have the potential to earn significantly higher returns than other investment options over the long term.
Benefits
Benefits of investing in stocks
There are many benefits to investing in stocks. Seven big ones are:
1. The potential to earn higher returns
The primary reason most people invest in stocks is the potential return compared to alternatives such as certificates of deposit (CDs), gold, and Treasury bonds. For example, the average stock market return has been over 10% annually since 1926 (before the Great Depression). For comparison, long-term government bonds have returned just over 5% annually during the same period, while the return on cash is slightly more than 3% annually (before the impact of inflation).
2. The ability to protect your wealth from inflation
Stock market returns often significantly outpace the rate of inflation. For example, the long-term inflation rate has run about 3.1% annually since 1913. That compares to a double-digit annual return from stocks. Stocks have been a good way to hedge against inflation.
3. The ability to earn regular passive income
Many companies pay dividends, or a portion of their profits, to investors. The majority make quarterly dividend payments, although some companies pay monthly dividends. Dividend income can help supplement an investor's paycheck or retirement income.
Dividends Per Share
4. The pride of ownership
A share of stock represents fractional ownership of a company. You can own a tiny slice of a company whose products or services you love.
5. Liquidity
Most stocks trade publicly on a major stock exchange, making it easy to buy and sell them. It also makes stocks a more liquid investment compared to other options, such as real estate investments, that you can't quickly sell.
6. Diversification
You can easily build a diversified portfolio across many different industries through stocks, which can help you diversify your overall investment portfolio. Your portfolio could also include real estate, bonds, and cryptocurrency, reducing your overall risk profile while improving returns.
7. The ability to start small
Thanks to $0 commissions and the ability to buy fractional shares with many online brokers, investors can begin purchasing stocks with less than $100.
Risks
Risks of investing in stocks
Now let's look at some of the drawbacks of investing in stocks. The biggest risk is stock market volatility. On average, the stock market declines 10% from its high every 11 months or so, 20% around every four years, and more than 30% at least once per decade. Because of that volatility, investing in stocks isn't for everyone. Here are a few reasons you might not want to buy stocks:
- You can't stomach the thought of a 10% (or greater) decline in your investment.
- You'll need the money within the next three to five years for a down payment on a house or to make another large planned purchase.
- You're retired or nearing retirement and need a fixed income stream more than the capital appreciation potential offered by stocks.
Beyond volatility-related concerns, there are other reasons to avoid stocks:
- You have a lot of high-interest-rate debt, like credit card debt. Paying off this debt can often yield higher returns than buying stocks.
- You don't have an adequate emergency fund. Having enough cash on hand to cover an emergency expense can prevent you from needing to borrow money with a credit card.
- You don't have the time or desire to research stocks to buy.
Start ASAP
Why should you start investing ASAP?
While there are some valid reasons not to buy stocks, the upside potential outweighs the risk for most people. So, investing in stocks is almost always a good idea, even when the market is at an all-time high.
Studies have shown that what's more important than timing the market is an investor's time in the market. Holding out for the right time to buy stocks can be costly because a large portion of gains often comes from a small number of days.
Meanwhile, stocks tend to recover from stock market corrections, or price declines of more than 10%, in a matter of months. The longer an investor is in the market, the lower the probability of losing money.
Equally important is picking the right stocks to buy. As David Gardner, co-founder of The Motley Fool, puts it, "It doesn't matter when you invest if you are investing in great companies." A minority of stocks account for a majority of the market's overall return. That's why it's better to buy stock in a great company as soon as you can rather than wait for a better price that might never come.
Related investing topics
For most people, the time to buy stocks is now
People who have money they won't need for a few years should consider investing in stocks since doing so offers the potential to earn the highest returns. Waiting to invest that money is more likely to have a negative impact on an investor's returns than a positive one. That's why the best time to buy shares of a great company is almost always right now.
FAQ
FAQ on why it's important to invest in stocks
What is the point of investing in stocks?
The point of investing in stocks is to grow your wealth. Historically, stocks have produced the highest returns compared to other asset classes, like cash, gold, and bonds, over the long term.
Do I really need to invest in stocks?
Unless your company offers a pension plan or you expect to receive a big inheritance, you need to invest in stocks to retire comfortably. They have historically produced higher returns than cash, bonds, and gold over the long term. Those higher returns can help you grow your wealth faster so that you can retire more comfortably.
Why would a person invest money in the stock market?
A person would invest money in the stock market to participate in the higher returns it has historically produced compared to other asset classes. Stocks have delivered higher returns than cash, bonds, and gold over the long term. Investing money in the stock market enables you to grow your wealth faster.
How much should I invest in stocks?
How much you should invest in stocks is a personal decision. A general rule of thumb is to have a diversified portfolio of 60% stocks and 40% bonds.
However, before investing in stocks, you should pay off high-interest-rate loans, like credit cards, and build an emergency fund to cover three to six months of living expenses. You also shouldn't invest money you'll need in the next three to five years, such as money you're saving for a down payment on a house.
