The stock market has a long history of producing profits for investors, but not everyone ends up a winner. By understanding the advantages and disadvantages of the stock market, you make more informed investment decisions, hopefully landing you in the winners' circle.
Pro: Historic Returns
Returning 10 percent, on average, per year since 1926, stocks outperform most other asset classes overall. From one year to the next, the return on a stock can vary drastically, but over a long time period (i.e., several decades), the stock market has produced this double-digit return. By comparison, bonds returned 5.4 percent a year over the same period. Stocks are generally considered more risky than bonds, but over the long run, your return for investing in the stock market is likely to be higher on average.
Diversification refers to buying a variety of assets in order to minimize the risk of one investment collapsing and wiping out your entire portfolio. Purchasing stocks that are involved in different sectors of the economy diversifies your stock portfolio and is a good hedge against losing your entire investment. Many people also diversify holdings in other assets, such as bonds or real estate, in addition to investing in the stock market.
Con: Loss of Funds
Regardless of how the stock market performs over the long term, you can still lose money. Companies go bankrupt, causing their share prices to plummet, or you buy and sell at the wrong time, leaving you with less money than you started with. The stocks listed on the NASDAQ stock exchange lost 78.4 percent of their value between 2000 and 2002, for example.
Con: Recovery Time
Prices constantly fluctuate and can take years to return to a former price after a decline. If you invested in the stock market as it was peaking in 2000, it would have taken seven years to recoup the capital lost on the decline. It took two years to recoup the losses that occurred during the 1987 stock market crash. Individual stocks may recover faster or slower than the market average.
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