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Why do people invest in stocks
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The stock market offers several benefits, attracting millions of investors worldwide every day. The primary reason people invest in stocks is to make a profit and grow their wealth over time. By investing in stocks, investors aim to capitalize on the growth in the value of their assets. Historically, stocks have provided a positive average annual return that is higher than other asset classes such as bonds and gold. For example, the S&P 500, which tracks the stock performance of 500 major publicly listed companies in the United States, has achieved a compound average annual growth rate of 10.7% over the past 30 years.
Additional reasons why people invest in stocks include:
- Accessibility: Investing in stocks has become very accessible today, with many brokers offering easy-to-use trading platforms. Additionally, you don’t need a lot of money, you can purchase a single share for just a few euros or dollars, and trading commissions have significantly decreased over the years.
- Liquidity: Stocks are traded on exchanges, making it relatively easy to buy or sell them on a daily basis. Compared to other asset classes, such as real estate, stocks tend to be more liquid. However, it’s important to note that not all stocks exhibit the same level of liquidity. Large-cap companies generally offer higher liquidity than small-cap companies, and U.S. stocks tend to be more liquid than those in emerging markets.
- Dividend income: Many companies allocate a portion of their profits to shareholders in the form of dividends. Dividends are cash payments that can supplement people’s income. The amount and payment of the dividend is usually decided on a quarterly or annual basis, according to how well a company has performed during the preceding period.
- Inflation hedge: Inflation is the general increase in prices over time, and it has averaged around 3.1% annually in the US since 1913. Inflation erodes purchasing power, making cash worth less over time. Historically, stock markets have provided returns that outpace inflation, helping to safeguard wealth against its effects.
- Time horizon: Before you start investing in stocks, you should consider your time horizon. By “time horizon” we mean that you should ask yourself: if you invest your money today, when would you need it again? Your time horizon will determine the type of investments you should go into and the kind of stocks you should consider. There are 3 main types of investing time horizon: short term (typically up to 3 years), medium term (ranging from 3-10 years) and long term (more than 10 years). The longer the time horizon, the more time you have to recover any losses thus the riskier the type of assets you can invest in.
- Investment goals: Next, consider your personal investment goals. Are you investing for an upcoming vacation, a wedding party in 5 years or are you saving for retirement? Your investment goals will determine your time horizon, which will in turn influence the level of risk you can take with your investments.
- Risk tolerance: As previously mentioned, before you start investing, think carefully about your time horizon and your investment goals. Those two will determine your risk tolerance. If you have a high tolerance for risk and a long term horizon, you couldconsider technology stocks or cyclical stocks, which tend to have higher volatility and higher expected returns. Conversely if you have short term goals and anticipate needing the money soon, you may want to invest in more conservative, low-risk stocks, such as defensive stocks, which are less volatile and have lower expected returns.
- Diversification: Buying one stock is akin to putting all your eggs in one basket, which is generally not advisable. Instead you should aim to diversify your portfolio by investing in a variety of stocks across sectors and even geographies. Diversification will help reduce your overall risk. If one position declines, others may not be affected as much or could even increase in value, thereby balancing out the overall volatility and return of the entire portfolio.
- Do not try to time the market: Timing the market involves attempting to buy or sell an instrument at the right time, essentially buying low and selling high. While it is possible to get lucky occasionally, consistently timing the market successfully is nearly impossible due to the highly unpredictable nature of market movements. If you wait for the perfect day to invest, you may never start, and as a result, you might miss out on valuable opportunities. The perfect day doesn’t exist. The best time to get started is now.
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