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The Pros and Cons of Investing in Stocks

Although both stocks and real estate investment trusts (REITs) are listed on the stock market, there are many differences between the two.

REITs are predominantly trusts that invest in properties and earn income through rental, leases and sales of their assets. Stocks, on the other hand, can be any kind of business, ranging from technology to healthcare.

Stocks are not regulated by the same restrictions that are imposed on REITs and therefore, have more leeway to conduct business and seize opportunities that REITs may not be able to. However, at the same time, because of this, stocks can sometimes be a more risky investment.

In light of these differences, I thought it might be useful to highlight some key advantages and disadvantages of each instrument. This is the second part of my series. In the first article, I focused on REITs while in this article, I will take a look at the pros and cons of investing in stocks.

What are stocks?

Stocks are shares of ownership of a company. Therefore, by purchasing a stock, you are essentially buying a part-ownership in the underlying business. With that, shareholders are entitled to benefits such as dividends and voting on corporate issues.

The value of the company can appreciate or vice versa. The change in prices in the long-term is due to fundamental changes in the business profitability and the value of the shareholder equity. Price can also fluctuate daily based on investor sentiment.

Advantages of stocks as compared to REITs

  • Many different types of stocks to choose from

There is a wide range of shares to choose from that operate in various industries. Investing in stocks can give investors exposure to different types of businesses. Many companies are also highly diversified themselves and operate in multiple different countries.

  • Stocks are not restricted by regulations

Unlike REITs, stocks are not restricted by how much they must pay out in dividends or how much leverage they can use. This means they have the flexibility to choose to retain their earnings to grow or to increase borrowings to expand their business. Having said that, if management is not prudent in the way they manage their finances, they may end up taking on too much risk.

  • May have better growth prospects

Stocks that operate in high growth industries are more likely to grow at a faster rate than REITs. Property is usually a slow and steady investment that does not appreciate very quickly.

Disadvantages of stocks as compared to REITs

  • Dividends are not predictable

Unlike REITs, stocks have the leeway to increase or decrease its dividends as and when they please. REITs, on the other hand, are required to pay out 90% of their income as dividends. As such, REITs have a more predictable dividend yield.

  • Stocks are more volatile

Historically, stocks have been more volatile than REITs. This is likely because REITs have a more predictable cash flow than most stocks.

  • Stocks are not as regulated by the exchange

REITs need to meet many criteria to be eligible as a REIT. Stocks, on the other hand, do not have too many requirements. As such, some stocks may be more risky investments.

The Foolish bottom line

Stocks and REITs each have their pros and cons. In my opinion, it makes sense to have exposure to both of them. However, before investing in either, investors need to know the differences between the two. Hopefully, these two articles give investors a good guide on the differences between the two.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.