I did not invest in my first stock until I was 27 year old. I did not know much about the stock market. So much so that in my first job I chose to forego stock options and chose cash instead. Life would have been very different if I had taken a little bit of time to educate myself early on in my career. I find that many young people go through a similar journey and could really benefit from starting their investment career early.
When it comes to investing your income, you do have many different options. There is real estate, bonds, certificates of deposit, and countless others. With all these choices available to you, why should you choose to invest in stocks?
In this article I will make a case on why you should consider investing in stocks. Once you are ready, you can learn more about how to invest in stocks here.
1. High Returns, Better than Most Other Instruments
Historically, stocks have returned better than most other asset classes. A typical long term return in the stock market averages between 8% and 10% (per year), while a bond investor tends to earn about half of this. Real estate averages out to about 3% per year.
There is quite a bit of variability in these numbers. Stocks are not one homogeneous asset class – these can be further sub-classified in many different ways. For example, smaller company stocks tend to do better than overall stock market over the long term, and so do the value stocks.
Similarly you can get more nuanced when you consider bonds or real estate. Emerging market bonds may give you better returns, while investing in commercial real estate is altogether a different proposition than flipping homes.
However, an average investor would generally do better investing in stocks for the long term.
2. Stay Ahead of the Inflation
The long term returns noted above are nominal returns. Inflation cuts into these returns significantly. A 3% long term inflation rate means that real estate is barely able to keep keep the value of your money even, while something like a certificate of deposit or short term bonds will actually lose you money over time as their returns tend to be lower than the long term rate of inflation.
Longer term bonds, lower quality bonds and stocks are almost the only instruments available to retail investor that can give you a better return than the rate of inflation.
3. Grow Your Wealth
Once you are able to increase the value of your investments above the inflation rate, you are now able to grow your wealth. The rate of growth depends on how rapidly you are able to compound your investments. The better your returns are, faster will your wealth grow because you are now able to reinvest more of your profits back into the market.
Stocks help compound your wealth in 2 different ways. Many stocks pay dividends. These provide you regular income, similar to bond interest. You could reinvest the dividends in purchasing more stock. Stocks may also increase in value over time as the company grows its business and makes the stocks worth more. This is called capital appreciation, and this is generally taxed at a lower rate than dividends, interest income, or regular income that other investment options may provide. When you sell these stocks, you are able to reinvest more of the profits back in the market for faster compounding.
4. Help Run the Economic System by Providing Liquidity to the Markets
The capitalistic economic system depends on worthwhile projects and companies able to raise funds to support their business. These funds come from the market in terms of public offering. Public offerings work because there exists a secondary market for the shares. Retail investors create the secondary markets for the shares.
If the stock market did not exist, companies would be restricted to only making debt offerings. This would severely reduce the liquidity in the capital raising market and slow down the economic activity severely, resulting in slower job growth and less prosperity.
5. Diversify Your Assets
Even if you invest in the stocks, you will very likely have other assets as well. If you own a home, you own real estate asset. You may own government bonds. Some people invest in art or wine. Others may buy private businesses.
Each of these investments can be profitable on their own, but they all bring risks that are unique to that asset class. They also have their own cycle. There may be years when the housing market is soft. Eventually it will firm up as the demand and supply adjust. However, during these times, it can be advantageous to own other assets that may not correlate to the housing market cycle. Stocks provide an asset class that can help you diversify and reduce asset correlation and volatility in your net worth.
6. Diversify Your Income Stream
If you are solely dependent on your job to provide you an income, you have a great amount of risk. Your job may go away, or the company may close or become irrelevant. You may become unable to work for whatever reasons. If you own stocks, dividends can provide you with another income stream that is independent of your job.
Similarly if you own rental property, you income can also ebb and flow. Stocks can help even this out with dividends.
Even if some stocks do not pay dividends, there is often much better liquidity and they can be sold or purchased at very short notice to give you access to cash as you need it.
7. Stocks can Provide Better Tax Benefits
Long term capital gains are taxed less than dividends or interest or other income. And you don’t have to pay taxes on any capital appreciation until you sell the stock. Many investors own stocks in blue chip companies for decades with significant appreciation in value. This value appreciates/compounds without a slice taken off in taxes.
Additionally, if you have your investment portfolio passed on to your successors after death, they are likely to receive the inheritance with adjusted cost basis, and a large part of the capital gains tax can be avoided.
8. Claim Your Part of the Producer Profits
If you think your compensation from your job is an adequate reflection of your productivity, you are sadly leaving a lot of money on the table.
The wealth you create with your productivity has two components:
- Your salary reflects what you get back as compensation, and,
- What is not paid back to you accumulates to increase the value of the company you work for
If you also own the stock in your company, you benefit from some of the increase in this value of the company.
Now, of course, if you buy stocks, you are not required to buy stocks in just your company. You can pick and choose where you want to invest. In general though, all the value of the businesses are eventually owned by the investors and the investors benefit when this value increases. If you are not an investor, you do not benefit. You are in fact helping the investors keep more of these profits, thus increasing the wealth gap in the society.
As you can see, investing in the stock market provides you with a number of benefits. Some go straight to your bottom line, others are more societal in nature. Regardless, you are better off if you invest in stocks.
You owe it to yourself to start early.