Benefits of Investing in Stocks
Despite its skyrocketing popularity and presence in the news, investing in stocks can seem like a rather formidable activity. The risk incorporated in the idea of stock market investing can deter people from diversifying their portfolios beyond fixed deposits, gold and mutual funds. However, by effectively managing your risk tolerance, investing in stocks can be vital in maximizing your investments.
As the legendary investor Peter Lynch once said, "The real key to making money in stocks is not to get scared out of them."
6 Benefits of Investing in Stocks
Here are some of the benefits of investing in the stock market:
Better Long-term Returns
Historically, the stock market (both Indian and international) has produced generous returns for investors over time. One of the key benefits of investing in stocks is the opportunity to be patient, and watch your money compound and grow. Though the prices of individual stocks ebb and flow daily, the overall stock market tends to grow in value.
An examination of several asset classes shows that the stock market is the source of the greatest historical returns for investors, outperforming all other types of financial securities and the housing market for several decades.
Looking back at the Indian stock market returns since the 1980s, the SENSEX and the NIFTY indices have rarely disappointed investors. Even considering setbacks like the 2008 recession and the 2020 pandemic, these stock indices have continued to grow exponentially, reaching an all-time high this year in October.
While past returns are no guarantee of future outcomes, the data does suggest that investing in stocks long term generally yields positive results if given enough time.
Dividends distributed by the company are a part of their profits that are a source of income for many shareholders. Typically, dividends are paid every quarter, but not all companies pay dividends. They may decide to reinvest this profit back into the company. Dividends are a way for companies to distribute a portion of their profits to shareholders, even if the stock has fallen in value.
Dividends received from the ownership of stocks can offer investors several benefits. Dividend payments can increase the total return on your investment in the stock. They also help lower volatility in the stock prices by helping support the stock price.
Consistent and growing dividend payments are generally an indicator of business stability and a growth in earnings. It is common for people to fund their retirement or augment their portfolio values through these dividend payouts.
Diversification Benefits & Liquidity
The stock market offers different financial instruments, such as shares, bonds, mutual funds, and derivatives, that offer investors a wide range of securities to invest in, as per their risk appetite and financial goals.
Investment in varied stocks also offers great diversification as it reduces your portfolio concentration. This flexibility is beneficial in mitigating the risks inherent to stock investing by enabling diversification of investment portfolios and offsetting market risks. A well-diversified portfolio helps build your wealth by leveraging growth in different sectors of the economy, resulting in a profit even if some individual stocks lose value.
Another benefit of investing in stocks is that they are highly liquid assets. They allow you to buy or sell stocks immediately without having to forage for buyers or sellers for your securities. The same cannot be said for other assets like real estate or long term debt instruments. Economists use the term "liquid" to mean that you can turn your shares into cash quickly and with low transaction costs.
Purchasing a stock essentially represents owning a stake in a company. A shareholder usually has the power to vote in the company's decisions. This ownership in the company ensures that the shareholders can drive the management's decisions that are beneficial to their interests.
Hedge Against Inflation
They say that if your money isn't moving forward, it's falling back. This is what inflation does to the purchasing power of money. To hedge against rising inflation in this economy, investment in stocks can be advantageous.
Historically, it has been seen that the returns on stock beat inflation rates. Rising prices can lead to more profit for companies, which in turn can boost share prices. It has been seen that growth stocks such as technology, FMCG etc. outperform the overall market and provide a solid hedge against inflation.
The Indian stock market is overseen and regulated by the Stock Exchange Board of India (SEBI). Investing in the stock market is safer and more transparent with the establishment of such an agency. The protection of the interest of investors is considered a priority by SEBI. This significantly helps in reducing risks due to fraudulent activities of companies.
Today, investing in stocks can be considered as one of the best ways to generate long term wealth. With a strategic investment plan, any investor can achieve their long term financial goals with the help of the stock market.
However, stock investment does not come without its fair share of risks. After all, the world of investment works on the simple principle of the risk-reward tradeoff: higher risk, higher returns. Before investing, one should be well-informed about the risks associated with stocks and how to manage risks effectively.
Here are some of the prominent risks stock market investors face:
Company-specific risk is probably the most prevalent threat to investors who purchase individual stocks. Investors can lose their money if the company they have invested in fails to produce enough revenue or profits. Poor operational performance can also cause a company's value to drop in the market.
Headline risk is often considered a subset of company risk. This is the risk of the stories in the media that would hurt the business and reputation of a company. One negative headline can lead to a market backlash against a specific company or an entire sector, often both.
A classic example is the crash of Tesla stock in early November. When Elon Musk published a tweet about whether he should sell 10% of his stake in the company made headlines. The stock value crashed shortly after this news made the headlines.
As an investor, one can experience losses due to the overall systematic risk plaguing the financial markets. Stock market crashes are an example of heightened market risk. Market risk cannot be eliminated but can be hedged against.
Liquidity risk is quite an important and intuitive risk associated with stock market investing. While most stocks and ETFs are highly liquid, they aren't equal. Some penny stocks or certain small-cap stocks may present some liquidity issues. Seamless buying and selling of these securities at their fair price could become a problem for investors.
The stock market is a great way to watch your money grow in the long term, but many people still avoid investing because of all the risks associated with it. However, in a developing economy like India, public investments and the overall sentiment of investors becomes extremely important in the growth of the economy. As a potential investor, you can rid yourself of the fear of investing in stocks and generate attractive returns by being fully aware of the risk you face and understanding your levels of risk tolerance.
Every investor is different. While someone may be willing to bet on extremely risky stocks for a chance to gain some staggering returns, someone else may be extremely risk-averse. At the end of the day, it is important to invest according to your unique risk appetite to keep emotion-driven and hasty investing decisions at bay. You can learn more about stock market investing on the IIFL website, and begin your investing journey.
Frequently Asked Questions Expand All
Yes, investing in stocks is a great source of long-term wealth generation for any individual investor. Stocks provide you with a variety of sectors and industries to choose from, helping you diversify your portfolio and mitigate your risks. Not only do they hedge against rising inflation levels, they also act as a source of regular income through dividend payments.
Some of the most prominent risks involved in stock market investing include:
- Company Risk: risk faced due to the downfall of an individual company
- Headline Risk: risk due to negative views in the media regarding a company
- Market Risk: risk faced due to the overall recession of the financial markets
- Liquidity Risk: risk faced due to the inability to liquidate stocks at their fair price, when required.