Advantages and Disadvantages of Investing in Equities

Advantages and Disadvantages of Investing in Equities

If you decide to invest in equities (as opposed to other options, which will be discussed later) here is a summary list of the pros and cons.

Equities come with both rewards and risk. The main rewards are capital gains — that’s when the stocks you buy go up in price — as well as dividends. Dividends are cash payments the company makes to its shareholders, often on a regular schedule.

Pros and Cons of Stock Investing

*Stock indices are baskets of stocks based on specific criteria. Indices are created and tracked by companies. Instead of buying individual stocks, you can buy exchange traded funds (ETF) or mutual funds that track a stock index. Through buying just one ETF, you could own a piece of hundreds of companies. I’ll discuss ETFs in the next section.

How to Invest in Equities

Individual stocks rise and fall in value. Individual companies can go bankrupt or massively grow creating huge profits. Exchange-traded funds typically include hundreds of stocks and are thus an average of what those stocks do.

A stock index ETF holding hundreds of stocks won’t likely drop much if one company in the index goes bankrupt. Conversely, the ETF also isn’t going to shoot higher if one stock does well.

For the average person, investing in exchange-traded funds is the better choice. It is lower risk than investing in individual stocks. You are unlikely to lose all your money, whereas if you put your money in a few stocks, and those stocks don’t do well, you could lose most of your money pretty easily.

Owning many stocks is called diversification. Risk is spread out over many stocks. Buying 30, 40, or 100 stocks individually takes a lot of time and will also likely generate a lot of commissions. Buying one stock index ETF means you instantly own a fraction of hundreds of companies with one transaction.

Ideally, invest in what are called large capitalization stock index ETFs. These include ETFs based on the S&P 500, the Nasdaq 100, or Dow Jones Industrial Index in the US. If outside the US, invest in a major index in your country, such as the Nifty 50 in India or the FTSE 100 in the UK, for example.

Many people also choose to invest in individual stocks. These methods require more research into which stocks to buy, and more time in learning how to implement the strategy. Such strategies include:

• Growth investing: Buying stocks that are expected to grow their earnings, and thus the stock price may increase as the company grows.
• Value investing: Buying stocks that are trading cheaply based on some metric such as earnings.
• Momentum investing: Buying stocks or ETFs which are being pushed higher by strong demand or interest in a product or service.
• Buy and hold investing: Buying stocks with strong fundamentals such as steadily growing earnings and sales, in-demand products, and a bright future outlook. Buy-and-hold stocks are often held for many years or even decades.
• Technical investing: Investing based on chart patterns or technical indicators based on the price fluctuations of a stock.

Investing in stocks requires a preferably low-cost broker, like Charles Schwab.

Equities Aren’t the Only Asset to Invest In

When people think of investing, they often think of the stock market. But there are many assets that increase in value over time. By investing in stocks you forego those other investments.

Let me preface by saying that investing in shares is a great choice. The S&P 500 stock index has a 100-year history of producing 10% yearly returns. That doesn’t mean the price goes up every year; it means that when up and down years are averaged, the result is a 10% return per year if holding the investment for decades.

That’s a great long-term return, especially considering how easy it is to buy (and later sell) an S&P 500 ETF, for example. All that is required is a brokerage account.

Bonds are another asset class that is generally less volatile than stocks but tend to produce lower returns, such as 5.59% per year. Real estate, and most importantly the land, is another asset to invest in. Farmland has generated an 11% yearly return.

To put that in perspective, even unopened sets of Lego increase in value at about 11% per year. Trading cards, like hockey and baseball cards, increase by about 12% per year. Art appreciates by 15% per year, and collectible comics can increase by 17% per year.

Some of these returns are higher than stocks, but remember that these aren’t liquid markets where you can easily buy and sell in seconds. You will need to buy or sell these items yourself, or with the help of an agent. It may include shipping, fees, and not being able to sell or buy when you want.

This is why investing in equities is so popular. It offers a great long-term return and is highly liquid, meaning you can buy and sell when you want and with minimal fees.