So you are finally ready to start funding an account to prepare for early retirement but you are uneasy about the stock market. Like any tough decision you make in life, it is time to weight the pros and cons. The advantages and disadvantages; the risks vs the benefits of investing in the stock market. The good the bad and the ugly if you will.
The number one advantage of investing in the stock market is the reason we do it; Gains. Investing in the stock market offers one of the best opportunities to grow your money. However, most people are uneasy about investing due to the potential risk involved. Afterall, you worked hard for your money and don’t want to lose it all in a bad investment. What we are really assessing here is how comfortable we are with the risks in order to achieve the greatest possible reward. In order to help you decide if investing in the stock market is right for you, here are the top 5 pros and cons to investing in the stock market to fund your early retirement.
Top 5 Pros to investing in the stock market
Pro – Historically consistent gains
When choosing any investment option, the goal should always be to achieve the highest gains possible with the least amount of risk. Investors in the stock market understand the risk (especially short term) involved in any single investment. However, if you look at the performance of the stock market over the long haul, the results are incredibly positive.
While interest rates have continued to decline to almost nothing, and the real estate collapse of 2008, combined with the ease in which you can now have access to brokers, more and more people are investing in the stock market than ever before. The number one advantage to investing in the stock market above all other investment options is the steady and consistent growth the stock market has shown over the last 100 plus years.
Depending on who you believe, the stock market, on average, has had anywhere between a 7% and 10% annual gain over the last 100 years. Lets look at the results of a simple $10,000 made using these results.
If you invested $10,000 and let it sit for 20 years at 7% annually, you would have $39,000 at the end of 20 years.
Fifty years would get you$295,000
100 years $8.7 million
You can see why stock market investing is a favorite option of people looking to grow their wealth. It is these steady and consistent gains over the last 100 years that provide the number one reason to invest in the stock market.
Pro – Liquidity
Stocks are easy to convert to cash. If you find yourself in a situation where you absolutely must have access to your money, stock market investments allow you to quickly and easily convert your investment int to cash. You simply sell off your position and instantly you have access to your money.
Compare this to purchasing a house as an investment and there is no comparison. If all of your money is tied up in the equity of a home and you need access to it, you would need to put the house up for sale, wait for the sale to go through, then closing, and so on. It could take months before you can access your money.
Pro – Fully Passive Income
Stock market investments are completely passive. When you buy shares of stock in a company, you own part of that company however you provide no work to the company. The gains you will see are completely passive and require you to do nothing.
Even better are companies that pay dividends. Some financial advisors will tell you that the dividend is the only truly passive income that exists.
A dividend is simply a company paying out a portion of its profit to shareholder. Companies pay dividends either quarterly or monthly and are announced on a per share basis. For example, a company may announce that they will pay a quarterly dividend of $.50 cents per share every quarter. So if you own 100 shares, you would be paid $50 in dividends.
I wrote an entire all about dividends which you can read here
Pro – Ease of Access
It has never been easier to become an investor in the stock market. Anyone who tells you that you need to pay crazy fees to have someone do this for you is either lying to you or very out of touch with the times.
I first started investing on my own in the stock market using E-Trade back in 2001 and I still use E-Trade to this day. I have many other accounts but E-Trade is by far my largest and longest running.
Apps like Robinhood allow you to trade with zero commissions. Imagine, an app that you can download to your phone, fund immediately, and begin trading with no commissions all within the same day. If you sign up with my referral link, we will both receive a free stock to start.
There are also other auto investors which you can fund automatically with regular automated deposits. One such app, Acorns, rounds up your linked credit card purchases and deposits the difference into your account. When you sign up you choose your investment mix and the app does all of the work for you. Acorns is another of my favorites. Learn more by clicking here. Sign up today and we both get 5 bucks.
Pro – Tax Breaks
Invest in the stock market and you will receive some tax breaks. Dividends and long term capital gains are taxed at a much lower rate than income tax. If you are working for your income not only are you trading your time for money, you are paying the highest percentage of taxes possible. probably in the 30%-40% range currently.
Capital Gains Tax
The IRS defines capital gains as either short term or long term. Taken directly from their website, “Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term. “ Credit IRS.Gov
” The tax rate on a net capital gain usually depends on the taxpayer’s income. The maximum tax rate on a net capital gain is 20 percent. However, for most taxpayers a zero or 15 percent rate will apply. A 25 or 28 percent tax rate can also apply to certain types of net capital gain.”
I implore you to do your own research before investing. here is a link to the IRS website where more information can be found. IRS.gov
Dividends
Like capital gains, dividends have 2 different classifications; qualified dividends and ordinary dividends. The difference is basically the length of time you held the shares of stock.
Ordinary dividends will be taxed at your normal tax rate which can exceed 37%.
If your dividends meet the definition of “qualified dividends,” they will be taxed at a rate of 0%, 15%, or 20%, depending on your adjusted gross income. The tax rate on qualified dividends is capped at 20%, which is for individuals in the 39.6% tax bracket.
Ordinary dividends become qualified dividends only after the holding period as defined by the IRS. And I quote, … “You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it.”
Got all that? Basically, you need to hold the stock for a while, the same as long term capital gains, in order to pay the lowest possible tax rates.
Tax Implications
Here is a quick example of the tax advantage of qualified dividends. Suppose you are paid $20,00 in dividends this year. At the end of the year, if your dividends are taxed as ordinary income, you are paying $5600 in taxes. Qualified dividends would cost you $3000. A savings of $2600.
Most importantly, rather than paying that money in taxes, it remains in your portfolio to earn even more dividends next year, and the year after, and so on, allowing you to capitalize on the power of compounding. For more on compounding, check out this article.
Top 5 Cons to investing in the stock market
Investing in the stock market is not without its disadvantages. As with any other investment options, you must weight the good with the bad in order to make a truly educated decision. Here are the top 5 cons when it comes to investing in the stok market to fund your early retirement.
Con – Returns are not guaranteed and you might actually lose money
Although gains in the stock market are historically consistent, future performance is not guaranteed. Historically, the stock market returns about 7% annually. This has been measured over long periods of time. One year the market may be down 5%, the next year up 20%. On average, 7% is what has been delivered.
What happens if your first year investing, the market only returns 2%? Or worse yet, it drops 15% like happened to me my first year? No matter how stable the market HAS been, there is always the possibility that you could lose some if not all of your money.
The likelihood of this goes up if you fail to educate yourself or invest wisely. Perhaps you decide to try to pick stocks. The market is up but you picked a bunch of losers and drop 10% while the DOW and S&P go up 12% and 15% respectively.
My point it, while it is certainly a possibility that the market can go down, the likelihood is low and there are things you can do to protect yourself against the risk. I guess it is best summed up by saying that investing in the stock market is easy but investing in the stock market safely requires hard work.
Con – Stock Market performance is effected by emotion
Emotions can affect the performance of an individual stock or the entire market. Irrational exuberance can help inflate a market while fear can bring it down.
You would have to be living under the rock to have missed the bitcoin craze which stretched into all of crypto currencies and included anything having to do with block chain technology that bit coin used. There was crypto kitties, an app that saw people paying tens of thousands of dollars for digital kittens. Then there was Long Island Iced Tea corp. The struggling beverage company that changed its name to Long Blockchain corp on December 21, 2017 and saw a single day stock price gain 289%. Long Blockchain Corp is the quintessential example of what can happen when a stock, or an area of the market becomes irrationally emotional.
Nothing pisses off an individual stock investor quicker then when an analyst downgrades their stock. Here you are chugging along with your investment, some analyst downgrades the stock based and almost immediately the price declines. Absolutely nothing changed about the way that company does business or their financial, yet the value of the stock suddenly drops based on nothing but the emotion created by the analyst who decided he didn’t like this stock.
Negative headlines can also cause problems with a stock that is otherwise reporting fantastic financial numbers monthly and quarterly. See Facebook in 2018.
Con -Paper Investment /You have no control
When you buy shares of a company, you are an owner of the company on paper. One of the pros mentioned earlier is that you do not need to do any of the work in order to profit. Conversely, you have no say in anything that happens.
Sure there are shareholder meetings where you can participate in votes on certain issues; however as far as the day to day operations, you really have no say. If the people that run the company make bad decisions and run the company into the ground there is very little you can do besides sell the stock,
Con -If the company goes BUST, you are paid LAST
As mentioned in the last con, you have no control over how the company is run. The people running the company might be incompetent, or dishonest and behaving unethically. It is always possible that the company you invested your hard earned money in could go bust.
You may not even be aware that they are participating in these activities before it is too late. If the company you invested in goes completely bust, as happened alot in 2008, you are paid last.
Con – You need balls of steel
The stock market is not for everyone. It will always fluctuate. Even in good times when you are seeing overall positive annual gains, your portfolio will almost certainly go on a roller coaster ride before the year ends and you look back on your overall positive performance.
If you are going to invest in the stock market, you will need to be able to handle the swings in your nest egg amount caused by market volatility. Sure it is nice to open up your account on a computer screen on a day that the entire portfolio is up 2%, but on those days where you are down 2% you will need to remain unshakeable and rock steady.
Have Patience
Investing in the stock market also requires patience. This ain’t the lottery although it has often been compared to a crazy casino. You will not get rich overnight by investing in the stock market. It will not happen in a year or even 5 or 10 years. It takes a long time to realize significant compound gains. Even at 10% annually it will take 7 years to double your money.
One of the cons of investing in the stock market is that you will need to have the fortitude to deal with the swings, and for decades. As your portfolio grows, it is even harder to look at the bad days. Warren Buffet once lost $4 Billion in one day on Apple stock alone.
I remember when I first started investing and at one point I was down over $5000 just about a year and a half in. I was ready to call myself a failure and quit. Then I got a great piece of advice from a friend/mentor who told me “You haven’t lost that money until you sell the stock.” I had forgotten why I bought those companies in the first place. The were good companies most of whom were falling victim to volatility and irrational emotional reactions to certain news, events, analysts ratings, etc. A year later I was up 14% and loving life.
Bottom line, you need to have balls of steel to invest in the stock market.
Conclusion
Stock market investing is not for everyone. Especially do it yourself stock market investing. Most people are just far too emotional, impatient, or uninformed to handle their own finances in this way.
It can be done, and it really is not that hard. You simply need to educate yourself so you understand what is required. Once you understand how to invest and how to lower your risk, it is really just a matter of mindset. Are you steady enough to handle the swings.
I can’t help you to be less nervous once you invest. However, Part 2 of this article will take a look at how you can lower the risk involved in stock market investing, By understanding how to manage your risk, you devise a strategy that eliminates many of the disadvantages listed above. Please follow the link below to access part 2.
PART 2: HOW TO MANAGE and lower THE RISK OF STOCK MARKET INVESTING
Earl