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Why invest in stocks and shares?

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To answer this question, it is necessary to look at the basic question of what is a stock or share of a company. Basically, it is buying a share of the company in the expectation that you are able to participate in the future earnings that the company generate. In exchange, you take in the risk of the company collasping and the opportunity costs of using the money (to buy the share) for other purposes.

So, in order for someone to take the risk to buy a share, he or she has to be pretty confident that the returns of the company will reward the investor for the risk taken. As the cliche goes, 'high risk, high returns'.

Looking it from the investor's viewpoint, since the investor wants to find a way to maximise the returns, the different ways that it can be invested has historically been in shares, bank savings account, fixed deposits, bonds(including government treasury bonds and corporate bonds) and gold/silver. The myriad ways that an investor can put money to work harder for retirement has in fact expanded to things like futures, forex, options, warrants, unit trusts, endowments, exchange traded funds and a whole hosts of ways to invest. Confused?

If an investor looks at investment and see only 3 ways to put it, say deposits into banks, buying shares and lastly puting it to bonds- then the picture can be clearer on what is the best investment tool.

From a company's point of view, if you need to grow your company, you can either issue more shares to raise capital (equity or shares), you can go to the bank to ask for a loan or you can issue a bond to the general public. Normally, for the company raising money from banks as a loan will mean a fairly high interest rates, for issuance of bonds, if the company is reputable, the bonds will be well received and the company can afford to set a low interest rate payable to an investor who buys the bonds for the promise of interest paid to him or her.

For the purpose of simplicity, we will not look at how or why a company should decide to issue more shares to the public to raise funds. If a company raise money through taking up a bank loan, it will mean that the interest that the bank charges on the company will be higher than the interest given to the investor who places a deposit there. This means that the company would have to grow by much more in order to repay the loan given by the bank in order to repay the principal plus interest. So if the company does grow bigger, the bank benefits by getting the loan repaid to it plus a hefty interest and the investor of the company will benefit from the increased earnings.

How has a average investor benefited from this economic activities going on? From a chart in Jeremy Siegel's book, Stocks for the Long Run. $1 invested in stocks in year 1801 has grown to a staggering $8.8 million in year 2001.

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The information contained in this blog is prepared from data believed to be correct and reliable at the time of publication of this report. The authors do not make any guarantee or representation as to the adequacy, accuracy, completeness, reliability of the information contained herein. Neither the authors or any affiliates or related persons shall be liable for any consequences (direct or indirect losses, loss of profits and damages) of any
reliance placed on information provided in the blog.

Shares and financial instruments illustrated in this blog can go down sharply or in certain instruments suffer total loss on the initial investments. Investors are advised to make their own judgment on the information provided and consult their own financial advisors or consultants as to the suitability of the products illustrated to their particular financial needs and objectives before acting on any information contained herein in this blog.