If you ask most people, they will tell you that investing in the stock market produces higher returns than other investments like mutual funds. For example, investing in stocks gives you the opportunity to grow your money through capital appreciation and through dividend. However, higher returns always means more risks. The stock market is volatile. A stock price can rise or fall dramatically within a short period of time. So before you invest your hard-earned money, not only is it important to make sure your debts are under control and that you have enough cash reserve in case of emergency, but it is also important to know the basics of the market and the principles of investing.
What is a Stock?
A stock represents partial ownership of a company. When you buy a stock in a company, you’re buying a piece or a share of a company. By owning a share, you own part of the company’s assets.
What Are the Advantages in Investing in Stocks?
There are two main advantages in investing in individual stocks. The first is that stocks can appreciate in value. Suppose you buy 100 shares in a company, ABC, for example at $10 a share for $1000. If in 5 months that stock rises to $15 a share, your initial $1000 becomes $1500. If you sell them, you would make a $500 profit minus commission fees.
Another good advantage in investing in stocks is that you can earn money through dividend. A dividend is a periodic payment issued by the company to its shareholders.
So when investing in stocks, you can make money not only through value appreciation, but also through dividends, that is of course if the company pays out dividends to its shareholders.
What Are the Disadvantages in Investing in Stocks?
Although stocks can provide better returns to an investor than other investments, they are also very risky. Stocks are volatile, meaning the price of a stock can fall as well as rise suddenly and unexpectedly. Just as it can rise to $1500, your initial $1000 investment at $10 a share can also fall to $200. The worst case scenario, you can lose everything if the company goes bankrupt.
How to Minimize Risks Involved in Investing in Stocks?
If you are a long-term investor, meaning that you buy stocks in hopes to keep them for 5 or 10 years, there are several ways to minimize risks. First and foremost, before you jump in, do your research carefully. If you are going to be a part-owner of a company, you should find out as much as possible about the company. Find out about the kind of business it conducts. Don’t just invest in a company you don’t know anything about. You must be able to understand what it does.
Moreover, find out about the company’s potential for growth, how much revenue does the company generate, how does the revenue growth compare with other companies in the same industry? In sum, don’t buy stocks in a company solely because your next door neighbor is also buying, unless that neighbor is Warren Buffet. Instead, take the time to carefully evaluate the company. For more criteria on valuing a company, check out The Intelligent Investor by Benjamin Graham.
Second, Diversification: a well-diversified portfolio will help you minimize risks. Third, have a long-term approach to buying stocks.
There is no doubt that investing in stocks is the best way to build wealth. However, there is a lot of risk involved especially if you hope to make a quick buck. Because the price of stock fluctuates in value, there is a chance to lose your money. However, if you are a long-term investor, the volatility of the market would not matter that much. But you must know the basics of investing. If you are interested in investing in the stock market and you want to add to your knowledge, start by reading Learn to Earn: A Beginner’s Guide to the Basics of Investing and Business.
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