Advantages and Disadvantages of Shares
Investing in shares means investing in little pieces of real businesses. As those businesses grow so should your wealth. What’s not to like? But as with anything in life good stuff doesn’t usually come along without at least a little of the bad so here are the key advantages and disadvantages of investing in shares.
—-Advantages—-
Inflation protection
Shares are the best way to stay ahead of inflation. Historically shares have provided the highest returns out of all the most common investment assets.
The chart below was put together from data in the Credit Suisse Global Investments Returns Yearbook 2018. It shows the annualized returns above inflation for different assets over 117 years.
And by the way. Those numbers are real, meaning inflation has been subtracted. Nominal returns were near 10% for global shares when you add inflation back in to the mix.
Convenience
Unlike classic cars or houses, shares are extremely easy to buy. These days you can be signed up with an online investment platform in minutes, leaving you free to buy and sell shares instantaneously. (If you don’t already have an investment account, we’ve compared some of the best here).
Inexpensive
Investing in shares has never been cheaper. Passive index investing and exchange traded funds have changed the game in terms of ongoing charges. There are funds out there these days with ongoing charges less than 0.05%.
Along the same lines, more and more stock brokers are offering commission free trades and the like. Investing today, is far cheaper than it was just a decade ago. The fees for buying and selling other assets are likely to be much greater than the fees for buying and selling shares.
Two ways to grow wealth
As with property you can earn money from price appreciation and through income in the form of dividends.
If you really want to maximize your returns, there’s nothing better than using that dividend income to buy more shares.
Investment size
Whereas you need thousands of pounds to buy houses, classic cars and artwork, you only need pounds to buy shares. You can literally buy a single share of a company or fund for less than one pound.
Buying such a low amount wouldn’t really be worth it unless your investment platform provides commission free trades (many do), but investing hundreds rather than thousands is within reach of just about everybody.
Ownership stake of a business
When you buy a share you become a minority owner of a business. Unless you are a multi billionaire your ownership percentage is going to be very small, but nevertheless, you will still be an owner.
As an owner you have voting rights, which enable you to vote on business decisions and leadership within the company.
In fact, buying a share of a business actually has certain benefits over buying an entire business. Namely, you don’t actually have to do anything! Instead, you can simply sit back and watch your wealth grow.
You can also sell your ownership stake in minutes. I don’t think there are many businesses that you could sell in their entirety in minutes. (I’m not even going to mention how long it would take to sell a house!)
Simplicity
Investing in shares is just about as easy as it gets, especially compared to the alternatives. While most of us can only imagine what hoops you need to go through to get your hands on a classic car or painting worth investing in, just about everybody knows what a hassle busying a house can be..
Yes, you may have a bit of research to do in the beginning, but once the decision is made all you have to do is add money at regular intervals, sit back and enjoy watching your balance increase.
Diversification
If you were 100% sure that a certain investment was guaranteed to give you a whopping return you could just stick all your money in that. However, that situation is unlikely. All investments have risks attached to them.
A great way to avoid the risk associated with a single investment is not to put all your eggs in one basket. Instead, you diversify. Shares are great for this because you can buy any number of them from different companies, different industries and different countries.
Funds take this to a new level. For example, each time you buy a share of a global index tracking ETF like Vanguard FTSE All World ETF your money gets spread out over thousands of companies throughout the world.
—-Disadvantages—-
Risk
Shares prices don’t just go up, they go down too. Single companies share prices can be hit hard if the company starts to perform badly. Stock prices really can go to zero.
In fact, entire countries’ stock markets can drop dramatically. Just ask the Japanese and Chinese.
At the time of writing the Chinese stock market is down about 40% from what it was prior to crashing about 10 years ago and the Japanese stock market is down a similar amount from what it was before it crashed about 30 years ago.
Crashes do happen and they can take a long time to recover. Historically, the Dow Jones in the US has crashed by over 40% eight times. In fact, it’s not that uncommon for all the worlds stock markets to go down together as they did in 2008.
Diversifying over a range of companies and countries and adding bonds into the mix helps to minimize the risks.
Taxes
Just like rental property, shares are liable for capital gains and income tax. If you sell your shares and they’ve made a profit you may be liable for capital gains tax.
Similarly, your dividends could be liable for income tax. The good news is UK residents and British expats are both eligible for the personal tax allowance, so you can earn money up to a point without paying tax anyway.
In addition, if you live in the UK, you’ve got tax sheltered options such as ISAs and SIPPs and expats who live in low tax destinations may not have to worry too much about taxes anyway.
Price fluctuation
Share prices can be volatile. In the short term the price of shares fluctuates. In fact, it’s not as uncommon as you might think to see double digit price drops in a single day, particularly with individual shares.
The good news is the longer the time horizon the less volatile shares become.
Keeping your investments diversified and having a long time horizon should help to keep volatility to a minimum.
Complexity
Most investors should be investing in funds. Index tracking ETFs are a great choice, particularly for UK non residents.
However, there are always going to be people who prefer to choose individual shares. Perhaps you think you are going to be one of the lucky few that actually outperforms the market or maybe you just like to have more control over your investments.
If you fall into this category you are going to have to perform a lot of research and investment analysis to determine your investment strategy and which companies to invest in. At the end of the day, if you pick the wrong companies you could lose all your money.
Paper Assets
When all said and done, when you buy shares, you don’t get anything other than a piece of paper to prove ownership. In fact, now that everything is done online you don’t even get that.
Some people prefer real assets that they can hold and touch. Property, being the most obvious, but wine, fine art, classic cars and gold coins are all things you can literally get your hands on.
The Bottom Line
For the vast majority it is going to be pretty clear that the advantages of shares far outweigh the disadvantages. In fact, so much so that anybody serious about growing wealth should probably consider buying shares.