Why Is It Important to Invest in Stocks?

The stock market has created an enormous amount of wealth over the years. Investing in stocks On average, the S&P 500, which includes 500 of the largest U.S. publicly traded companies, has returned 8% to 12% annually. Only $10,000 invested in the stock market 50 years ago would have grown to more than $380,000 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 its level of volatility is not for everyone. But if you can manage your fear, stocks have the potential of earning significantly higher returns than other investment options over the long term.

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 bank certificates of deposit, gold, and Treasury bonds. For example, the average stock market return has been about 10% annually since 1926; long-term government bonds have returned 5% to 6% annually during the same period.

2. The ability to protect your wealth from inflation

Stock market's 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.

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. That can help you diversify your overall investment portfolio, which 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 of investing in stocks

Now that we've covered the benefits of investing in stocks, we'll look at some of the drawbacks. The biggest risk of investing in stocks is stock market volatility. On average, the stock market declines 10% from its high about every 11 months, 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 why 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 some other 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.

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 it's almost always a good idea to invest in stocks 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 comes from a small number of days.

Meanwhile, stocks tend to recover from stock market corrections, or earning 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 accounts 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 waiting for a better price that might never come.

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For most people, the time to buy stocks is right now

People who have money they won't need for a few years should consider investing in stocks since it has the potential of earning 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.