In the world of finance, the main hero is money, but when it comes to increasing it, other instruments become relevant. An example of this is investing in stocks. The process of investing capital in securities for the purpose of gaining profit can be confidently called a classic of stock trading. But is it actually profitable?
In this article, we will take a look at the advantages and disadvantages of stock investing, and give some helpful tips on getting started.
Advantages of Stock Investing
Stocks have a lot going for them, especially since nowadays anyone can trade in stocks by registering with one of the popular brokers, like brokstock.co.za or tastytrade. But if we had to highlight 3 main advantages of stock investing, they would be leverage, diversification, and tax benefits.
Leverage can be used to generate substantial profits with a relatively small investment by magnifying the invested amount. However, leveraging can also result in adverse outcomes, potentially leading to significant losses of up to 100%.
Another advantage of stock investments is the possibility to diversify the investment portfolio. By buying stocks of different companies and industries, the risk associated with a single stock can be minimized.
Theoretically, investors can also deduct expenses such as custody account fees as income-related expenses for tax purposes – provided they are incurred as part of an intention to generate profits.
Disadvantages of Stock Investing
Of course, investing in stock is not perfect and there are some disadvantages we need to mention.
Risk of Loss
Stock prices are subject to fluctuations. In crashes or bear markets, stocks can lose an average of 50% or more in value. In the case of individual stocks, a total loss is also possible in the event of a negative business trend.
Between the last stock exchange price of the previous day and the opening price of the following day, a large gap can occur. In this case, even a stop loss order does not protect against the losses incurred “overnight”. Besides, the insolvency of a public company usually means that the shareholders go away empty-handed.
Apart from trading, a longer-term investment horizon of several years is necessary for stocks due to unpredictable price developments. Stocks do gain an average of 7% to 9% per year, but returns are anything but constant. If you invest at an unfavorable entry point, you may have to wait several years, even for first-class stocks, until initial losses are recovered and a worthwhile return is achieved.
Strategies to Maximize Profits
There are a lot of tips and tricks to stock investing. You have to do research, figure out your goals and so much more.
Research Stocks Before Investing
Researching and analyzing the stock is work that all investors need to do. During the research, you will need to figure out what companies, industries, regions, and countries you are going to invest in. During analysis, investors need to take a look at various key figures, which include:
- Profitability. Look at how profits have developed in past years.
- Price-earnings ratio. Relate earnings per share to the current share price.
- Price-to-cash flow ratio. The cash flow indicates how high the freely available cash inflows of a company are. Here, you need to relate the cash flow per share to the share price.
- Dividend yield. A company’s dividend, i.e. the proportion of net income attributable to a share each year, is an important signal for investors.
- Equity ratio. This ratio can – but does not necessarily have to – be an indication of how crisis-proof a company is. The higher the equity, the better the company might be able to weather economic crises.
Such analysis and research are essential for successful investing.
Understand Investment Goals
The definition of your investment goals should be at the top of your agenda. After all, the right goals are the basis for a successful strategy that will help you achieve your investment goals step-by-step.
The most common goals include:
- Security. For many investors, security is the top priority when it comes to investing. The loss of capital should be avoided at all costs. because in times of strain on the statutory pension system, safe capital should be saved for old age.
- Wealth accumulation. Basically, every investor wants to increase their money and improve their own financial situation. It does not matter whether you start small or already have a lot of capital, when it comes to asset optimization, the focus is on a high return. If you really want to build up wealth, you have to set your investment goals differently in terms of risk tolerance and the duration of the investment.
- Acquisition. Accumulating capital can also be used for a major acquisition. In that case, the primary goal is asset preservation as well as moderate and steady asset growth. The investment horizon is also usually shorter because you already have a rough plan of when you want to make the corresponding acquisition. Liquidity is also important because the invested capital must be available at the planned time.
- Retirement provision. Securing retirement financially is a major goal for many investors. Here, too, the security of the investment is the top priority, because only very few investors want to speculate with the money for their retirement.
- Passive income. Another investment objective may be to be able to live off the regular interest income from the chosen investments. This can be, for example, dividends from the stock portfolio or a cash flow from real estate.
Without figuring out your goal you are unlikely to achieve satisfactory results.
Set Stop Losses
With stop losses, you set a specific lower price limit for securities, such as stocks or funds from your portfolio. If this limit is reached or even undershot in the market, the monitoring system of your chosen broker automatically triggers a sell order.
If you do not want the loss of a security investment to exceed a certain percentage, set the stop price a percentage below the price at which you purchased the security. This way, the risk of larger losses can be limited to a certain extent.
Stock investing offers both benefits and risks. It is important to learn in advance exactly which markets and companies to invest in to minimize risk. Diversification of the portfolio can also minimize risk. In addition, you should think about a longer investment horizon in order to be able to profit from the potential of stock investments.