The Advantages of Trading Stocks
Corporations sell shares of stock to raise capital to provide for day-to-day expenses and finance growth. In exchange, investors are granted ownership rights over the underlying firm. These claims fluctuate in value, according to corporate earnings power. Share prices for companies that are at risk of bankruptcy will collapse towards zero. Alternatively, the value of your investment may increase towards infinity, because corporate earnings power in unlimited. Beyond financial gain, investors contemplate buying shares of stock for liquidity and control purposes.
Over the long term, stock market returns outpace the gains available upon competing assets, such as, savings accounts, bonds, and real estate. The Standard and Poor’s 500 Index (S&P 500) serves as a benchmark for the United States stock market, and has averaged 11% annual returns since its creation in 1957. The S&P 500 is composed of 500 large cap stocks, such as ExxonMobil and Microsoft.
Stocks are ideal savings vehicles for long-term goals, such as retirement and college education financing, because investments compound over time to build wealth. Compounding describes a snowball effect, where growth builds upon existing returns. For example, one $10,000 investment in the stock market becomes $11,000 after one year of 10% returns. After two years of 10% returns, your investment is now worth $12,100. The stock earned $1,100 in its second year, or 10% of $11,000. Your lump sum investment may double itself within one decade—because of compounding returns.
Stock market investments offer liquidity. Liquidity refers to the ease of which assets are converted into cash. Liquidity is important to provide financial relief amidst emergencies, or pay for competing investments that are more attractive than your current holdings. Organized stock markets, such as the New York Stock Exchange and NASDAQ, allow investors to sell stocks immediately for cash to prospective buyers. Alternatively, real estate and direct small business investments may require several months, or even years, to liquidate.
Shares of stock allow you to participate within the financial gains of corporations—without putting out large outlays into illiquid assets to build businesses. For example, founding a bank may require millions of dollars to buy real estate, hire staff, and market your institution to prospects. Rather than raising millions of dollars to lock yourself into creating this business, you may buy into an already established bank, such as Wells Fargo, for the price of one share of stock.
Voting Rights and Control
Larger investors buy stock in companies to influence management decisions and guide business operations. One share of stock represents one vote, and you may control any corporation by owning more than 50% of its shares. Further, investors acquire corporations outright through buyouts that purchase all equity from existing shareholders. Large investors may seek control to replace current management with their own team of leaders. Struggling companies often require management changes to unlock value and grow profits. Alternatively, current corporate insiders may purchase additional blocks of stock to ward off these hostile takeovers.