Advantages & Disadvantages of Investing in Common Stocks
Ownership of U.S. common stocks was a very profitable investment through most of the 20th century, especially for those who held their stocks over a long period. On the other hand, not all investors can or will hold their stocks for long enough so that they can afford to disregard the tremendous day-to-day volatility in the price of common stocks. You should design your own portfolio with both of those points in mind.
Other People Are Reading
-
History
-
The stock market, over long periods of time, records high rates of return relative to many other forms of investment. During the decade of the 1950s, the price of stocks on the S&P 500 increased by an average of 13.2 percent per year. If you count the effects of dividend disbursements, that percentage goes up to 19.3. Even accounting for the rate of inflation during the same period, the real total return was 16.7 percent.
The stock market did not perform as well as that in the 1960s or 1970s. Indeed, in the 1970s, which was a time of unprecedented inflation in the U.S., the real total return of stocks was slightly negative (minus 1.4 percent). The market did very well again, in both nominal and real terms, in the 1980s and 1990s. The early years of the 21st century, however, were negative.
Time Frame
-
The real total return for an average year within the whole period 1950 to 2009 was 7 percent, which is much higher than the results that would have followed from keeping money in a passbook savings account.
-
Considerations
-
With regard to any particular stock position, you have to make a choice: Do you buy the stock and hold on to it over a long period of time to get the benefit of long-term value appreciation and a dividend stream, or trade in and out of those positions to meet short-term specific cash needs and in order to get a short-term view of the direction of a stock's movements? If you stick to a buy-and-hold strategy, you have voluntarily adopted a policy of illiquidity, tying up that chunk of your assets. On the other hand, if you trade in and out you incur transaction costs, as well as subjecting yourself to the short-term volatility and unpredictability of the market.
Effects
-
On May 5, 2010, the Dow Jones Industrial Average lost 600 points in only five minutes. It regained most of that "flash crash" loss by the close of trading that day. Still, the incident illustrates how volatile, and thus how scary, the market in common stock can be. As Maria Bartiromo, of CNBC, has put it, the flash crash proved that a stock "can go from $44 to $4 faster than you can say 'flash crash.' "
Warning
-
Another drawback of ownership of common stock is that it is subordinate to all forms of debt, even preferred stock, in the event of a corporate liquidation.
-
