What is the Point of Financial Markets?

The key word is shift of consumption, that is consumption timing of individual investor.

Some individuals in an economy are earning more than they currently wish to spend. Others, for example, retirees, spend more than they currently earn. How can they shift their purchasing powers from high-earnings periods to low-earnings periods of life?

One way is to “store” their wealth in financial assets. In high-earnings periods, they can invest their savings in financial assets such as stocks and bonds. In low-earnings periods, they can sell these assets to provide funds for their consumption needs. By so doing, they can “shift” their consumption over the course of their lifetime, thereby allocating their consumption to periods that provide the greatest satisfaction. Thus, financial markets allow individuals to separate decisions concerning current consumption from constraints that otherwise would be imposed by current earnings.

Anyway these actions are not performed without some risk. Investing in bonds is usually considered as a smaller risk while investing in stocks represent greater risk to potential investor in securities. This allocation of risk also benefits the firms that need to raise capital to finance their investments in real assets. When investors in financial assets are able to select security types with the risk-return characteristics that best suit their preferences, each security can be sold for the best possible price.