If you are considering taking the plunge into the stock market, common stocks are a good place to start. When you own a common stock, you own a piece of a larger business. For a young investor, this is a way to get a small piece of bigger action.
But like any investment, there are advantages and disadvantages to common stock. While common stocks allow investment with limited liability and a high earning potential, they are also the last to get paid if a company is liquidated and make it difficult to manage your investment.
Common stocks give you the benefit of investing in a company with limited liability and a high earning potential. However, you're the last to get paid during liquidation and have less control over your investments.
Investment With Limited Liability
One of the best advantages of commons stocks is that they allow you to invest in a business with only a limited liability. This is because your liability is limited to the amount of your investment. So if you invest $1,000 in a company, for example, that's the most you can lose. This is good news if your investment goes bad and the business ends up owing creditors a lot of money.
Last to Get Paid
An important disadvantage of common stock is that if the company is liquidated, you likely will not see a dime. This is because common stockholders are last in the pecking order. Bondholders, other debt holders and preferred stockholders must be paid what they are owed before money would be distributed to common stockholders. If there's nothing left, then you're out of luck.
High Earning Potential
Common stocks have the advantage of offering a high earning potential. Compared to bonds or certificates of deposit, they provide a better opportunity to make a larger return on investment. These other investments are guaranteed, so you know the minimum and maximum amount that you stand to gain from them.
However, common stocks have no limit. While this means that you may lose money, it also means that there is no limit to how much you can gain.
Lack of Control
A disadvantage of common stocks is that it can be difficult or impossible to exercise control over your investment. If you invest in your own business, you can make decisions about your strategy and business practices. When you invest in common stock, you are subjected to the will of other stockholders. The only way to gain control is to gain a majority share in the investment – an expensive proposition for most corporations.