Common stocks are securities that represent ownership in a specific corporation. When you hold them, then you can exercise control by electing a board of directors or voting on corporate policies.
Stockholders with common stock or at the bottom of the priority ladder for the ownership structure. If liquidation occurs, then common shareholders have rights to company assets after any bond obligations, preferred shareholders, and other creditors receive payment in full. That means this investment option is riskier than debt or a preferred share.
It also means that this investment resource usually outperforms bonds and preferred shares from a long-term perspective. Most companies will issue all three types of securities.
We have been looking at the advantages and disadvantages of common stocks since 1602 when the Dutch East India Company issued its first shares and began the Amsterdam Stock Exchange. These are the critical points you will want to review.
List of the Advantages of Common Stocks
1. You can invest in companies with limited liability.
When you purchase common stock in a company, then your personal assets are not at risk if the organization gets into legal trouble. The extent of your liability is the amount that you put into the investment. That’s good news for you if the stock goes bad and the business ends up owing creditors a lot of money or faces a significant judgment. Although you will be out the money that you put into the organization, the loss could be something that helps you when you file your taxes for that year.
2. Common stocks offer a higher earning potential.
Although investing in common stocks provides more risk than conservative options like a certificate of deposit or a money market account, the returns are typically better. Because your returns aren’t guaranteed as a shareholder, there is no limit to how much you can gain. If you don’t mind taking some of the guarantees away from the minimum and maximum amount that you can earn, then your wealth can start growing more over time with this option.
As with any investment, there is also an opportunity to lose everything when you purchase common stocks. That’s why a measure of caution is always a good idea when looking at this option.
3. You can easily purchase common stock on virtually any trading platform.
If you don’t mind buying or selling common stock at market prices, then you have a highly liquid investment that you can convert into cash at almost any time. Virtually any trading platform will let you open an account to purchase this asset at any time. You can also work with a financial advisor to complete these transactions. Most of the industry has moved to a zero-fee approach for trades, so it doesn’t cost you anything to buy stock or sell it. The ease of this investment makes it a simple way to diversify your portfolio.
4. Common stocks can provide dividends.
Some companies will pay dividends when you purchase common stock and hold it for a specific amount of time. These organizations will pay a particular amount based on the number of shares that you hold in the company. Some will pay monthly, others quarterly, and annual payments are also possible. If you invest in these dividend stocks, then you can help your wealth grow by creating a ladder of returns that you can use.
5. You can trade common stocks in a variety of ways.
Online traders make it simple and inexpensive to trade common stocks from major exchanges around the world. You can work with brokers who allow margin trading and short selling for eligible listings. That means you can use borrowed funds to purchase stocks or sell borrowed securities in the expectation of buying them back at a lower price. Options on specific stocks to hedge against market volatility or guess on price movements.
6. You’ll get to take advantage of a growing economy.
When the economy begins to grow, then so do corporate earnings. That’s because this outcome works to create employment opportunities, which then creates more income. As profits get higher, more sales occur, and that means higher levels of consumer demand that drive revenues into the black. If you can identify where a company stands in its business cycle, then your potential to grow wealth through investing in common stock is incredible. Just make sure that you hedge your bets by diversifying your portfolio instead of investing in only one stock.
7. It’s the best way to get ahead of inflation problems.
The average rate of inflation in the United States hovers around 3%. Common stocks have averaged an annualized return of 10% historically. That means the value of your portfolio can grow at a net of 7% each year. If you were to put your money into a savings account or CD that provided a 2.2% return, then the actual value of your cash would go down for the year. Investing in common stocks is the best way to get ahead of inflation problems in most years, even if you see a loss happen here or there.
8. You can leverage the value of common stock as collateral.
If you are in the market to purchase a big-ticket item, then the value of your common stock can be used as collateral for a loan or a line of credit. The liquidity of this financial asset is what makes this leverage possible. Lenders understand that they can use the stock as a way to pay off a future debt if you run into financial trouble. Because this lowers the overall risk of lending money to you, it may become possible to secure a lower interest rate when buying a new car or another significant item.
9. It is possible to buy and sell common stock around the world.
Do you want to purchase common stock for your portfolio? Then you have access to a world of opportunities. Several markets in numerous countries are open for trading when you secure an online account with an appropriate level of access. That means your money can work for you around the clock if that’s what you feel your investments require. New York, London, Tokyo, Singapore, and more geographic locations provide ways to gain equity in companies so that you can work to beat the rate of inflation with your value growth each year.
List of the Disadvantages of Common Stocks
1. You are the last person to get paid during a company liquidation.
If the organization goes into liquidation and you hold common stocks, then you are going to be the last person who gets paid. Most shareholders that use this investing option rarely see any of their money come back in that situation. If there is nothing left after every creditor, debt holder, and preferred stockholder get what is due to them, then you’re just out of luck. That’s why a diverse portfolio that works to manage your risk factors is the best way to resolve this disadvantage.
2. You don’t have much control over your investment.
Although you may get awarded with voting rights when purchasing common stocks, it is often difficult or impossible to exercise any control over this investment. If you were to put that money into a company that you control, then your decisions on strategies and best practices can lead to a profitable experience. When you add common stock to your portfolio, then you are subjected to the will of every other stockholder.
The only way to invest in common stocks and avoid this disadvantage is to gain a majority share of a company with your investment. That’s an expensive proposition to consider for most corporations, so it is only available to those with the highest levels of wealth.
3. Your portfolio can lose substantial value in a single day.
The stock markets around the world are highly volatile right now. Frequent price swings of several percentage points could happen in a single trading session. Not only is it possible for your portfolio to gain a substantial amount in a short period, but there is also the potential to lose everything in a single day. If you decide to trade on margin, that means a margin call and the forced liquidation of stocks could happen at a significant loss.
4. Companies are not required to pay dividends on common stocks.
Although some organizations regularly pay dividends on common stocks and have done so for decades, there is no obligation for a company to take this action. Shareholders who use this investment vehicle are not obligated to receive a portion of the profits that a business earns. That means part of your risk factor in choosing this investment option is that you can lock in a loss for a thinly traded stock in fast-moving markets without realizing what you are doing. The downside risks are very high, which is my mutual funds are often a priority when investors first start to trade.
5. You might need to navigate several different common stock classes.
Some organizations issue multiple classes of common stock. You might see Class A, Class B, or Class C shares – and so on. The advantage of this structure is that the owners gain access to capital markets while retaining control and warding off potentially hostile takeovers. The disadvantage goes to the investor who has lower voting rights, trading volume, and liquidity issues and some of the lowest share classes.
6. It can take time to generate significant gains.
When Six Flags announced that its efforts in China weren’t going to be paying off as well as they hoped, the stock took an immediate nosedive of nearly $8 per share. That means over five years of gains were wiped out in just hours for some investors. If people purchased the stock in recent days, then they experienced a significant loss overnight.
If you decide to purchase stocks on your own, then you must research each company to determine its potential for profitability. It is up to you to learn how to read financial statements and understand the information provided in annual reports. You must also have time to monitor the stock market since even the best company’s prices will fall during market corrections, crashes, or bear environments.
7. Investing in common stock can be an emotional rollercoaster at times.
The prices of common stock rise and fall all of the time. Trading that occurs around the world can impact the results of your equity value at any time of day. You must avoid the trap of buying high when the market seems strong and selling low because you’re afraid that you might lose everything. If you tend to worry about your finances, then the best thing to do is to avoid looking at the constant price fluctuations that occur. Just make sure that you check in regularly to verify that your portfolio’s performance is meeting your financial goals.
8. You will face high levels of professional competition when investing in common stocks.
Professional traders and institutional investors have more time to monitor the stock market and research companies. That means their work has a competitive edge against your investing efforts if you don’t have the same amount of time available. These folks have access to sophisticated trading tools and financial models that reduce their risk factors when making and investing decision.
Unless there is a specific dividend stock or investing strategy to implement, beginners typically approach the stock market through guesswork. You have to compete with those professionals to earn a return. That isn’t always easy to do.
Common stocks are a suitable investment for most people. It’s a limited way to gain some market exposure for your savings that you can manage without taking a lot of risk. Although the potential for losing money is present, a savings account or certificate of deposit will also lose value if inflation rates are higher than the promised return given to you.
Even if you only have a few dollars to invest each month, working with fractional providers who can give you access to some of today’s top-performing shares can be a way to make your money start growing.
The advantages and disadvantages of common stock must be carefully considered, just as they are with any other investment. You have the potential to gain a lot of wealth from this activity, but there is always a risk of loss to manage. That’s why I diversified portfolio that includes these investments is a balanced way to provide for your future.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.