Pros and Cons of Buying Stocks

Quick Answer

Investing in the stock market can help you build wealth over time and even take advantage of some short-term opportunities. But there's also the risk of losing money, especially in the short term, and taxes can get tricky.

Young investor buying stocks, holding phone and coffee

Buying stocks isn't for everyone, but including them in your investment portfolio, along with mutual funds, exchange-traded funds and other assets, can help diversify your portfolio and potentially offer greater returns over time.

Buying stocks has both benefits and drawbacks to consider, especially if you're a new investor. It's important to consider several factors before making a decision about your portfolio. Here's what to keep in mind.

Pros of Buying Stocks

Whether you buy stocks individually or through a fund, there can be several advantages for your portfolio.

Long-Term Gains

The stock market can fluctuate quite a bit in the short term, but it can be a great place to put your money to work for long-term goals.

The average annualized return for the S&P 500—a stock index that tracks the 500 of the largest companies in the U.S.—has been roughly 10% since its inception in 1957. If you're saving for retirement or have other financial goals that span several years, short-term volatility often smooths out into a general upward trend.

Many stocks also offer dividends, which can further increase your returns.

Short-Term Opportunities

While most investors should avoid trying to time the market, there can be some excellent opportunities to earn sizable short-term gains if you're a savvy and experienced investor.

Easy to Buy and Sell

Opening a brokerage account typically only takes a few minutes, and once your account is funded, you can buy and sell stocks fairly easily. If your broker offers a mobile app, you can often trade stocks with just a few taps on your screen.

It also doesn't require a lot of money to get started. Many online brokers now offer fractional shares, which allow you to buy a portion of a company's stock instead of one full share. Minimums can be as low as $1.

A Sense of Ownership

If you love a certain company's products or services, owning shares of its stock can give you a sense of ownership in something you enjoy. You can also include stocks in your portfolio from companies that align with your values, such as sustainability, social justice or diversity.

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Cons of Buying Stocks

While there are some great reasons to invest in the stock market, there are also some downsides to consider before you get started.

Risk of Loss

There's no guarantee you'll earn a positive return in the stock market. In fact, investors are regularly cautioned that the past performance of a stock—or the market as a whole—doesn't guarantee future results. Stocks are most susceptible to losses in the short term.

Even in the long term, though, there's no guarantee that you'll generate the returns you want. If there's an economic downturn and an ensuing stock market crash at the wrong time, it could be financially devastating.

If you're looking for an investment with less risk—albeit with the potential for a lower return—you may consider bonds, money market funds and other low-risk options.

The Allure of Big Returns Can Be Tempting

Reading stories about investors making it big on short-term investments can make you feel like you can do it too. Online chatter and the media can bolster false confidence, even among inexperienced investors.

But investing with your emotions—whether excitement or fear—can get you in trouble fast. Before you try your hand at active trading in the stock market, it's important to research strategies and learn how to use the sophisticated tools and resources that the experts rely on.

Gains Are Taxed

With few exceptions, stock market gains are taxable when you sell your holdings. If you sell a position that you've held for less than a year, any gains you earn will be taxed at your ordinary tax rate.

If you hold on to a stock for more than a year, you'll be able to take advantage of a lower long-term capital gains tax when you sell. But that cost will still eat into your return. Even if you have a tax-advantaged investment account, such as a 401(k), individual retirement account (IRA), health savings account or 529 plan, you may still be subject to taxes in certain situations.

It Can Be Hard to Cut Your Losses

If a stock you invested in performs poorly, you may be tempted to hold on to it until it bounces back. If you can't bring yourself to cut your losses and make the necessary adjustments, your portfolio may continue to suffer.

How to Decide if Buying Stocks Is Right for You

If you're investing with a long-term goal in mind, such as retirement or education savings, the stock market can be a great place to put a good portion of your portfolio.

If you have some short-term financial goals, however, you may be better off putting the money in a low-risk vehicle, such as a high-yield savings account or certificate of deposit. If you're around five years out from your goal, you may opt for a mix of stocks and bonds, with more of your money in bonds to reduce your risk exposure. You may also consider other assets, such as real estate.

If you've decided to put some of your money in stocks, it may be a good idea to start with stock index funds, which can help diversify your portfolio, minimizing the risk associated with each individual stock. Once you have a good mix of stocks, you can consider investing in individual companies. But again, try to avoid putting too much of your portfolio in one stock or industry.

Instead of buying stocks based on recommendations, research the companies you want to invest in, so you can judge whether or not it's a good bet.

The Bottom Line

The stock market comes with a lot of ups and downs, so it's important that you understand what you're getting yourself into before you start investing. As you consider the benefits and drawbacks of stocks, think about your financial goals, including when you'll need the money, and your risk tolerance to determine the best way to diversify your portfolio.

You may also consider consulting with a financial advisor who can provide personalized and professional advice for your situation.