Why invest in stocks is one of the most common questions we receive from beginner investors. We all have financial objectives in life: to pay for college for our children, to be able to retire by a reasonable age, to buy the things we want, to become financially independent. Saving money is essential to financial success, but it is only part of the story. Smart savers start by building sufficient emergency savings. But after building six to twelve months of easy-to-access savings, investing in the financial markets offers many potential advantages.
Investing in stocks is quite simple and flexible nowadays, making it one of the best ways to make your capital passively work the hardest.
Grow your capital with limited effort
One of the primary benefits of investing in the stock market is the chance to grow your money with little time needed compared to alternatives. Over time, the stock markets tend to rise in value, though the prices of individual stocks rise and fall daily.
Investments in stable companies that can grow tend to make profits for investors. Likewise, investing in many different stocks will help build your wealth by leveraging growth in different sectors of the economy, resulting in a gain even if some of the individual stocks may lose value.
Money sitting in cash will lose its value
The cost of living and the price of goods, such as food and clothes, increase in alignment with the inflation rate. Sitting in cash will always feel safer than investing in the stock market, but the stock market gives much higher odds of increasing your standard of living and fight inflation.
Data over the years shows that storing cash under the mattress has been a recipe for wealth erosion. Over the last 100 years, US treasury bills (debt instruments backed by the US Government), usually used as a cash proxy, underperformed the US stock market by 6.9% p.a (0.8% inflation-adjusted returns the last 100 years).
Gain dividend income
Some stocks provide income in the form of a dividend. While not all stocks offer dividends, those that do, deliver annual payments to investors. These payments arrive even if the stock has lost value and represent income on top of any profits that come from eventually selling the stock.
Dividend income can also help fund a retirement or pay for even more investing as your investment portfolio grows over time.
Diversification
For investors who put money into different types of investment vehicles, a stock market investment has the benefit of providing diversification. Stock market investments change value independently of other investments, such as bonds, gold, crypto, and real estate.
Holding stocks can help weather losses to other investment products. Stocks also add or reduce risk to an investment portfolio, assisting investors in increasing their risk basis or reducing overreliance on conservative investment strategies.
Power of compounding
Compounding is a process where the interest earned on an investment is reinvested along with the original investment, making the interest become part of the future principal. This phenomenon allows seemingly tiny amounts of money to grow into large amounts over time. To give you an idea of how strong compounding is in increasing your wealth, $450 invested per month compounded by 10% per annum will be over $1,000,000 after 30 years.
Compound interest has been called the eighth wonder of the world. And with good reason. It magically turns a little bit of money invested wisely into a whole lot of cash. Albert Einstein is said to have called it one of the most outstanding mathematical concepts of our time. However, investing is a game of patience, so to take full advantage of the power of compound interest, investments must be allowed to grow and compound for long periods.
Stock markets have performed better than its competitors
Historically, the US stock market has delivered generous returns to investors over time (7.7% inflation-adjusted returns in the last 100 years). US stocks have outperformed corporate bonds, which have outperformed government bonds, which have outperformed cash, which interestingly has generally outperformed the commodities.
S&P 500 index (the basket of the 500 largest US companies) had an 88%, 95%, and 100% chance of achieving positive returns in a 5, 10, and 20 years time frame, respectively.
Ability to be part-owner of the company you love
A share of stock represents fractional ownership of a company. This means that investing in the stock market also benefits from being one of a business’s owners.
As a result, if you utilize a business product or service that you own shares in, whether it be for dining, shopping, or any other reason, you are assisting in the success of that business and, ultimately, contributing to an increase in the value of your own shares.
Though investing in stocks may require more work and carry a higher degree of risk than other investments, the higher potential return that stocks provide cannot be easily ignored. The most significant risk of investing in stocks is stock market volatility. On average, the stock market declines 10% from its high every year, 20% around every four years, and more than 30% at least once per decade. Because of that volatility, investing in stocks is not for everyone.