“When s*** hit the fan, is you still a fan?
When s*** hit the fan (one two, one two)
When s*** hit the fan, is you still a fan?
When s*** hit the fan, is you still a fan?” – Kendrick Lamar (Mortal Man)
The Truth About Investing
Let’s face facts. There are two extremes when it comes to investing; you either end up becoming an investing whiz like Warren Buffett, or lose it all in the trenches of financial crashes like most of America. When I started researching for this post, I was startled by how few posts talk about the disadvantages of investing. With the exception of a handy article by The Balance, pretty much all of the results on the first page weren’t from 2017. Did all of the cons of investing somehow just disappear? If you invest, are you guaranteed to become a millionaire? Blasphemy.
If you’re like many of my readers, over the past year or more, you’ve been reaching out to friends in your network to figure out how to go about investing. You’re likely asking which sites and apps to use, what books to read, and how much to start off investing with. You might’ve read a post that said that “the earlier that you invest, the better your odds are of retiring comfortably”. Something about compound interest. Money that earns on top of money. Yup, probably something like that.
Investing is a great way to earn passive income. No doubt about it. Putting your money into investments is a better life decision than putting it into a savings account that’s getting its value nibbled away by inflation. Fair enough. Technology continues to lower the barrier to entry, as new fintech startups attack the market share of incumbents.
Personal finance is a hot topic and everyone is looking for a piece of the pie. But what about the downsides? Did the “Great Recession” just not happen? Did America get flashed with a Men and Black neuralyzer? Keep a pair of shades at all times, my friend. Investing has its disadvantages and they’re crucial to know as a fresh investor. For the sake of a constructive dialogue, we’ll keep this post focused on stocks opposed to bonds.
Let’s break this post down with a brief introduction of advantages and then a deep dive into disadvantages.
Advantages of Investing
When you own a piece of stock, you own a piece of that company. You get share of their success. Because you own a percentage of the company, when their earnings growth causes their stock price to rise, you make a profit. If you’re employed at a company, but don’t own any stock, no matter how hard you work, your earnings are not directly correlated to the company’s success.
Easy to buy and sell
With the power of technology, it’s easier to invest that ever. Nerdwallet created a list of the best investing apps. You can invest through a broker, financial planner, or online. The power of technology enables users to get started quicker than ever before. There’s information about different investment opportunities all over the web. Just as it’s easy to buy stock, in today’s age, we’re also able to sell our shares with the click of a button.
Historically good returns
Over the long haul, stocks are considered great investments. Historically, the overall stock market returns roughly 7 percent on an annual basis. This is why every financial expert says to get started early. The more years your money is invested, the likelier that you will accumulate a pretty penny over time, thanks to our friend compound interest.
Less expensive and time intensive than starting a business
Any entrepreneur will tell you that building a profitable business is harder than passing a drug test after hanging with Wiz Khalifa for a weekend. For the average Joe, investing is a way to still get a piece of the action. It’s less expensive and takes far less time. Depending on your investment style, keeping an investment account may only take a few hours of maintenance a month. It’s a small price compared to building a publicly traded company from scratch.
Now that the core advantages are out of the way, let’s dig into the disadvantages.
Disadvantages of Investing
You can lose all of your money
What happens when the company that you invested in ends up losing three of their biggest clients that account for over 60 percent of their revenue? You can guarantee that the financial markets will downsize their stock price considerably. You didn’t do anything wrong, but you’re paying for it. What if it’s not just one company in your portfolio, but 50 percent of them? This isn’t uncommon in times of economic distress. Investing during a rough spot in the economy may keep you in a work uniform for a decade longer. Ask your elders.
If you can’t play the “buy and hold” game, you’re pretty unlikely to make much money
Investors are incentivized to buy stocks and hold them for long periods of time. Not only from a tax perspective (more on this later), but also from a profitability perspective. Companies take time to grow. Investing usually isn’t a quick fix, especially for the average investor. High-frequency trading sounds sexy, but it probably isn’t for you. So, if you need your money for something in the near future, investing probably isn’t the best option for you.
You have limited control over the company’s operations
Not being a company founder has its benefits, as mentioned in the advantages section. However, it also has its disadvantages. Think about folks who invested in Enron. In cases like this, you can’t control what’s going on inside the company. You may get the chance to vote on a few company decisions, but for the most part the day-to-day operations are run by company employees. And sometimes employees do some pretty dumb stuff.
If you sell your investment in less than a year, you pay higher taxes on your profits
One advantage that comes with owning stock is its lower tax rate. If you hold an investment for more than a year, any profit that you receive will only be taxed at 15 percent (20 percent for high earners). This is called “capital gains tax”. But what if you sell your stock in less than a year? Instead of paying capital gains tax, you pay your regular income tax rate. In most cases, it will likely be higher than the capital gains tax. Less money to take home to the bank.
Investing is hard on the emotions
Everything is fun when you have a good stock that’s growing in value year after year. But what about when your company is suffering after lower than expected earnings? What if the whole entire market is down? You can lose most of the money that you invested in less than a year. It’s not that easy to be an investor when chaos ensues. The financial markets reward those with tough skin and stable nerves. That’s why most investors never win big and it’s part of the reason why financial advisors are helpful. It’s damn hard to keep your cool and make sound decisions when bad news keeps coming. But good judgment pays off big in the long haul.
Investing is completely non-intuitive
Buy low and sell high. Sounds easy enough right? But let that statement sink in. If you’re buying low, that means you’re buying a stock with lower demand. Your friends may be talking bad about it, financial experts are shouting about how its price has dived over the past three months. At this point, most investors run away. But this is exactly when you should buy. Most investors purchase high when all of their friends are talking about the company and the market has already swallowed whatever good news that provided the jump in price. It’s damn hard not to follow the crowd.
Even the professionals get it wrong
I would not advise any investor to have a portfolio 100 percent filled with stocks. In fact, the everyday investor should only send a small percentage of their cash into individual stocks (15 to 20 percent). More of their money should go into diversified investments like exchange traded funds (ETFs). Why? Because even “experts” are wrong most of the time. Most hedge fund managers don’t beat the S&P 500 over a ten year period. They have a full staff, resources, and deep relationships in the industry. If you’re playing the long term game, take on less risk and bet on the whole market opposed to individual stocks. Play smart.
You don’t get the same returns as the founder
Investing can give you some pretty amazing returns over time, but probably not as fast as entrepreneurship. There are some advantages that come along with putting in sweat equity. There’s no such thing as getting rich quick, but successful entrepreneurs typically get rich quicker.
Now that you’ve learned about some of the disadvantages of investing, you’re better equipped to improve your investment journey. Stay tuned for Part 2 of this ongoing series.