Last month I discussed the importance of establishing an investment plan in order to fund your long-term lifestyle and retirement. My focus was on the advantages and disadvantages of real estate investments, both residential and commercial. This month I want to look at the different elements involved in stock market investing.
Some people are naturally drawn to real estate investments over the stock market, as they like the tangible reality. Others are attracted to the potential and volatility in the stock market. However, it is crucial to understand the advantages and disadvantages of both options in order to ensure that you are using the investment tool that best suits your needs.
There are several advantages to investing in the stock market.
- Diversification. The fact that we now live in a global village means that we are able to diversify our investments both geographically and across industries and developing markets. Your diversified funds run a much smaller risk of being depleted by a single catastrophic event (eg a company, country or property going bankrupt). You can break your funds down and diversify each section. You can fix different risk levels for different parts of your investment plans, and choose to invest different proportions in various stocks, bonds, Exchange Traded Funds (ETFs), currencies and industries, to name just some of the options available.
There are also different types of financial instruments that include derivatives and options (the explanations of which are beyond the scope of this article) that can provide even greater flexibility to knowledgeable investors who are putting together diversified and hedged portfolios.
- Increased liquidity. Although portfolios should not be constructed with a view to selling overnight, financial portfolios have the advantage of increased liquidity in the event of an emergency, or a change in situation that necessitates more immediate access to funds. However, this advantage needs to be balanced by the knowledge that when investors are too trigger happy about selling, it often leads to very bad overall results. Decisions to liquidate a portfolio should always be carefully considered, and never be a knee-jerk reaction to a specific situation.
- Long-term investment growth. Long-term investors have seen consistent growth over time. The Israeli stock market in particular has consistently shown excellent gains over time with the Israeli market even out performing many other western economies on an overall risk-adjusted basis. The shekel was and remains an extremely strong currency, in contrast to other local and western currencies whose values have eroded. Potential investors should ensure that the Israeli stock market features in their long term investment plans in order to properly diversify and lower the overall risk of their portfolio.
- Income producing investments. Stock market investors can create portfolios that contain a long-term income stream that could potentially provide additional living expenses. This option is especially valuable to investors who are enjoying their retirement. A portfolio that is structured to include these investments enables the account owner to receive monthly or periodic dividends which can represent a very helpful income.
- Transparency and regulatory supervision. All companies traded on the stock market are subject to regulatory supervision, which means the investor can receive accurate information regarding the companies being invested in.
- Tax deferral. Through compound investing available through different financial instruments (like ETFs and mutual funds) investors can defer tax and maximize long term gains.
- Financial portfolio management. Depending on the investor’s ability and familiarity with the stock markets, it can be relatively easy to put together a financial portfolio and either self-manage or hire an advisor to oversee the portfolio. Those investors who aren’t comfortable selecting and overseeing their portfolio can and should still be instrumental in choosing the general direction and risk level, and maintaining contact with their financial professional to ensure that their investments continue to follow their long-term strategic plan.
Obviously there are also disadvantages to stock market investing.
- Risk of ownership. Unfortunately companies and even countries can and have gone bankrupt. People who invest in an entity that then goes bankrupt can potentially lose all of their investment.
- Professional investors. When investing in the market, one is competing against professionals which can place the average amateur investor at a disadvantage.
- A sentimental market. Ultimately the market is set up based on supply and demand. This means that emotions can sometimes play a major part in stock market investing, and investors can be dragged through roller coasters, with stock prices fluctuating due to global ‘whims’ rather than fundamental changes.
- Diversification. That same diversification that offers you the potential to minimize losses as you spread your wealth also means that if you only invested a small portion of your funds in a very successful element – the profit will be only on that small portion.
- Time consuming diversification. The more diverse your portfolio the more time consuming it is for you to oversee and manage. Recognize that you will have to dedicate a significant time under most circumstances if you are managing your own money.
- Market downturns. As with all investments there are no guarantees, despite diversification. Sometimes there can be market downturns, as there was in 2008-9 when all stocks dropped, which limited the advantage of diversification.
- High volatility. One of the major characteristics of the stock market is its potential for high volatility. When you have your investment portfolio set up – barring any emergencies or unforeseen situations that demand funds immediately – don’t be scared into making rash decisions regarding the sale of your investments should the market suddenly drop. Your portfolio should be assessed regularly to ensure that it’s in line with your medium and long-term needs, and decisions then made in a calm manner. But the fact that the market can and does fluctuate, sometimes very drastically, can be a major disadvantage depending on your stage in life and personality.
- Huge selection. There is a huge range of investment options within the stock market which can be daunting for those less knowledgeable about the financial markets. If you aren’t confident about your ability to research and organize your portfolio on your own, ensure that you have a professional who can help advise you, and if necessary manage your account, to maximize your chance of investment growth.
The stock market can represent a real opportunity for the investor. However, that potential needs to be recognized for what it is and what it can be. If you feel that the stock markets could be the correct investment tool for you, get professional advice if necessary and ensure that you are fully aware of the options available and best way to structure your portfolio. And then, you can also have stocks and shares working for you.