The advantages and disadvantages of investing

Investing is buying stocks and other assets and holding them for the long term. A long-term investment horizon often uses a passive investment strategy​, meaning there is little active buying and selling (trading) happening. However, some investors may choose to enter and exit positions every few years or when their investing strategies​ tell them to do so.

In either case, here are some advantages of investing.

The stock market has historically risen over the long term at a greater rate than inflation. Therefore, investing in stocks not only offers the chance to protect capital from inflation but to increase wealth, over time, as well.

Long-term average returns for the S&P 500 index have been around 10% per year, and for the FTSE 100, near 7.5% per year (accounting for dividends reinvested). Learn about the best long-term stocks​ to watch.

Please note that past performance is not a reliable indicator of future results.

Investors who own stock indices or index ETFs have little work to do. By being invested in an index, the market does the work for them. Investors just hold the positions for the long term to achieve market average returns.

Investing is like saving, but funds can grow at a much higher rate than most savings accounts offer. Most investors opt to save for retirement and/or for future expenses. While some emergency cash can be kept in a saving account, many investors opt to put a large proportion of their savings into investments that earn a greater rate of return.

Investing provides options. While stocks are a common investment, so are bonds, ETFs, real estate investment trusts (REITs), and precious metals. Bonds issued by stable companies or governments tend to have less volatility than stocks but also have lower long-term returns. That said, they often offer returns that are higher than a savings account. Therefore, even if stocks have little appeal to you, there are other options for investment.

The long-term return on stable government bonds is between 5% and 6%, while stable corporate bond yields are slightly higher.

Long-term investments are typically treated more favourably in terms of taxes than short-term trades. There are also certain investment accounts that may further protect investment gains from taxes, such as a stocks and shares ISA.

Whether it’s now or later, investing can provide regular income from dividends (stocks) or interest (bonds). When a bond or dividend-paying stock is purchased, it pays a certain percentage to you at regular intervals. This income stream can be reinvested to take advantage of compounding returns or used for something else.

Investing is not a one-size-fits-all process. Investors choose how to invest in stocks​ and which stocks or ETFs they want to own. An investor chooses an asset allocation that is based on their risk tolerance — for example, holding more stocks for higher returns or holding more bonds to reduce volatility in the portfolio.

Here we’ll look at some potential disadvantages of investing, as well as how it compares to some other forms of trading.

When investing, there is a possibility of loss. While major stock indices, such as the S&P 500 and FTSE 100, have risen over long periods of time, there are no guarantees that the market will rise during a specific investor’s time horizon.

Investing doesn’t compound capital as quickly as successful short-term trading does. Therefore, all else being equal, a good investor will make lower returns than a good day trader or swing trader.

Investing is generally passive, with trades lasting long periods of time and little active buying and selling. This may not appeal to investors who like doing lots of research and being active in the market. That said, there is always the option to be active in the market but also have some funds invested as well.

When we invest, we are giving up the use of that capital in exchange for potential earnings over the long run. An investor could be using that capital for something else. For example, we might use it to redo our house, take a vacation, go back to school, or start a business (some of these are alternative forms of investment). But ultimately, if we allocate capital to investing, it can’t be used for something else, at least not while it is invested.

Consider this before investing. Investing sees the greatest benefit when funds are left in the account to compound over time. If we are constantly pulling out funds from our investment account to use on other things, many of the benefits of investing may be lost.

The main alternative to investing in common assets like stocks or bonds is to trade. Trading is buying and selling stocks for profit as the price fluctuates. There are two common forms of short-term trading: