You may be wondering: “How does the stock market work?” Additionally, “What are the potential dangers of investing in stocks?” If you are worried about these things, you aren’t alone. Some people with limited financial experience are terrified by the possibility of losing their money in the stock market. That, or they’re unaware of the dangers that are presented by the stock market. But the reality is, that investing in the stock market carries a lot of risks. However, it can be approached advantageously in order to build up your savings smartly. The average person keeps most of their net worth within reach. In contrast, the affluent and extremely rich generally have most of their wealth invested in stocks. And they do this for a reason.
What Are Stocks?
In order to understand how the stock market works, let’s delve into the actual definition of a stock:
A stock is a financial instrument that represents ownership in a company or corporation, as well as a claim on its assets and earnings. Stocks are also referred to as shares or equity.
Owning stock entails owning a “slice” of the company, equal to the number of shares held as a proportion of the company’s total outstanding shares. For example, owning 100,000 shares of a company with one million outstanding shares means having a 10% ownership stake in it. Most companies have outstanding shares that run into the millions or billions.
Stocks represent ownership equity in a firm. They give shareholders voting rights as well as a residual claim on corporate earnings, in the form of capital gains and dividends. Individual and institutional investors come together on stock exchanges to buy and sell shares in a public venue.
Share prices are set by supply and demand while buyers and sellers place orders. Order flow and bid-ask spreads are often maintained by specialists or market makers in order to ensure an orderly and fair market. Listing on exchanges may provide companies with liquidy as well as the ability to raise capital. However, it can also mean higher costs and increased regulation.
Advantages and Disadvantages of Stock Investing
Here are just five pros, as well as five cons, of investing in the stock market.
We’ll start with the pros:
Take Advantage of a Growing Economy
As the economy grows, so do corporate earnings. This is because economic growth creates jobs, which create income, which creates sales. The more income people are getting, the higher the consumer demand, which drives more revenue to companies. So, when the economy is doing well, you can use it to your advantage by investing in the market.
Stay Ahead of Inflation
Historically, stocks tend to yield generous returns over the long term. In fact, the return rate from stocks can sometimes be higher than the inflation rate. This means you can compensate for inflation with your earnings. However, this does mean you must have a longer time horizon.
Stocks are Easy to Buy
The stock market makes it easy to buy shares from companies. You can purchase stocks through a broker, a financial planner, or even online. You can decide to buy stocks and follow through with the idea in a matter of minutes. If you own a small business, you may even be able to invest in stocks through your business.
You Don’t Necessarily Need a Lot of Money to Start
Most retail brokers allow you to buy and sell stocks commission-free. Additionally, some don’t require account minimums. And, if the stock you want to buy is too expensive, you can even buy fractional shares if your broker allows for this.
The stock market allows you to sell your stock at any time. Economists use the term “liquid” to mean that you can turn your shares into cash quickly, with low transaction costs. And that’s important if you should end up suddenly needing your money.
And now, cons:
If a company does poorly, investors will sell, sending the stock prices plummeting. This could result in you losing your entire investment. If you can’t afford this risk, you should try a more secure investment, another, more secure way of saving, or some mix of these based on your risk tolerance.
If you’re buying stocks on your own, you should research each company to determine how profitable you think it will be before you buy any of its stock. You should learn how to follow your company closely as well as monitor the market itself. Even the best company’s price will fall in the event of a market correction, market crash, or bear market. Taking so much time and paying so much attention to your investment may not be ideal.
Stock prices rise and fall fast. In addition to keeping up with the market and your company being stressful, watching the ups and downs of the market can also be worrisome. As we mentioned previously, assess your risk tolerance.
If you sell your stock for a loss, you may be able to get a tax break. However, if you sell it for a profit, you’ll be liable to pay capital gains taxes. There are ways of reducing the tax burden on your investment, however.
Institutional investors and professional traders have more time and knowledge to invest than the average person. You may have professional competition, and they may have more tools at their disposal than you do.
We Can Offer Advice
Want to know how to invest in the market smartly, assess your risk tolerance, and discover ways of keeping your money safe? We can help with that! We can help you determine how much of your money should be in stocks based on your specific situation. Reach out!