If you were to ask a financial expert, they would tell you that stocks are an essential component in the creation of wealth over a long period. However, predicting the day-to-day fluctuations of stocks with absolute precision is an impossible task, despite the fact that their value can greatly increase over time.
The question that arises is: How can one generate profits in stock trading? In reality, it is not difficult as long as one follows established techniques and exercises patience.
How to make money in stocks
1. Pick an investment account
In order to purchase stocks, you will require an investment account. Similar to a bank account, an investment account allows you to deposit money, which can then be used to acquire stocks. However, it is important to note that an investment account, such as a Roth IRA, 401(k), or traditional brokerage account, does not serve as an investment in itself. Rather, it serves as a designated space where your investments are stored.
By considering the various types of investment accounts, you can potentially reduce your tax expenses and it might be advantageous to possess multiple diverse investment accounts.
Financial advisors frequently advise individuals to begin their investment journey by utilizing a 401(k), which is an investment account provided by employers. This advice is particularly emphasized when employers offer matching incentives. Subsequently, they typically suggest that individuals explore either a Roth or traditional IRA for advantageous tax benefits. Finally, if there are funds available beyond these accounts, financial advisors recommend considering a traditional brokerage account.
2. Consider index funds
There is a simpler way to profit in the stock market rather than purchasing multiple individual stocks if you desire to make money. Index funds consist of numerous stocks, sometimes over a hundred, that mimic a market index like the S&P 500. As a result, you do not require extensive understanding of the individual companies in order to achieve success.
By opting for index funds, you can invest in multiple stocks simultaneously without the need for individual management. Employing fund investment can reduce your risk since the potential impact of a company going out of business is more significant when you are invested in only a few companies compared to if you are invested in a larger number, such as 500 companies.
Although it is possible to achieve higher returns with individual stocks compared to an index fund, it requires thorough research on companies and also carries a higher risk of potential losses.
3. Check out dividend-paying stocks
If the company pays dividends, having more time in the market also allows you to collect them.
If you are actively trading on a daily, weekly, or monthly basis, you will likely miss out on collecting dividends as you will not hold the stock during the important payout periods on the calendar. Alternatively, you can opt for investing in exchange-traded funds that offer high dividends, similar to index funds.
4. Buy and hold
Long-term investors often say, “It is better to spend time in the market than to try to time the market.”
What does that entail? Essentially, a common method to generate profits in the stock market involves implementing a buy-and-hold approach. This entails holding onto stocks or other securities for an extended period instead of participating in frequent buying and selling activities (also known as trading).
Do you not believe it? It is important because investors who frequently engage in daily, weekly, or monthly trading tend to overlook chances for substantial yearly profits.
According to Putnam Investments, individuals who stayed fully invested throughout the 15-year period until 2017 received an annual return of 9.9% from the stock market. However, if you engaged in frequent market entry and exit, you put your chances of attaining these returns at risk.
- For investors who missed just the 10 best days in that period, their annual return was only 5%.
- The annual return was just 2% for those who missed the 20 best days.
- Missing the 30 best days actually resulted in an average loss of -0.4% annually.
It is evident that missing out on the market’s best days results in significantly reduced returns. Although it may seem easy to always be invested on those days, predicting when they will occur is impossible, and days of impressive performance can sometimes follow days of significant declines.
In order to capture the stock market at its peak, it is necessary to remain invested for a long period of time. One way to accomplish this is by adopting a buy and hold strategy. Additionally, this strategy can benefit you during tax season by making you eligible for reduced capital gains taxes.
5. Opt for funds over individual stocks
Experienced investors are aware that diversification, a well-established investment practice, is essential for minimizing risk and potentially increasing returns in the long run. Consider it as a financial strategy similar to not placing all of your eggs in a single basket.
Typically, experts recommend stock funds, such as mutual funds or exchange-traded funds (ETF), over individual stocks to maximize diversification, despite most investors being attracted to these two types of investments.
To imitate the automatic diversification found in funds, it can take a considerable amount of time, investment knowledge, and a significant cash investment to purchase a wide range of individual stocks. For example, buying one share of a single stock may require several hundred dollars.
Funds, however, provide the opportunity to purchase shares that represent hundreds or thousands of individual investments. Although many people desire to invest all of their money in promising companies like Apple (AAPL) or Tesla (TSLA), the truth is that even professionals struggle to accurately forecast which companies will yield high returns.
Experts advise the majority of individuals to invest in funds that passively follow significant indexes such as the NSE Nifty or BSE Sensex. This approach allows you to profit from the stock market’s approximate average annual returns of 10% effortlessly and inexpensively.
6. Reinvest your dividends
Shareholders of numerous businesses receive a dividend, which is a regular payment determined by their profits.
Even though the dividends you receive may seem insignificant, particularly in the early stages of investing, they play a significant role in the overall growth of the stock market throughout history.
The Nifty 50 has achieved approximately 12% returns since it started, but when dividends were reinvested, the percentage increased to nearly 16%. This can be attributed to the fact that reinvesting dividends allows for the purchase of more shares, which ultimately aids in faster compounding of earnings.
Financial advisors often suggest that long-term investors reinvest their dividends instead of using them immediately. This is due to the added benefit of compounding. Many brokerage firms provide the option to automatically reinvest dividends through a dividend reinvestment program (DRIP).
Excuses that keep you from making money investing
When the stock market experiences a small decrease, investors become anxious and sell in a rush, which is similar to goods going on sale and everyone being afraid to buy. However, when prices increase, investors eagerly jump in, resulting in a common tendency to “buy high and sell low.”
In order to steer clear of either extreme, investors must gain an understanding of the common falsehoods they often deceive themselves with. Here are three major ones:
1. ‘You’ll wait until the stock market is safe to invest.’
Investors who are too afraid to buy into the market often use this excuse after stocks have declined, whether it be for consecutive days or over the long term.
However, when investors mention that they are awaiting safety, they are essentially referring to the rise in prices. Therefore, waiting for a sense of security is essentially a strategy that results in paying elevated prices. In reality, investors often pay for nothing more than a false sense of security.
Loss aversion is the driving force behind this behavior, as psychologists explain that investors prioritize avoiding immediate losses over attaining future gains. Consequently, individuals are inclined to take desperate measures to prevent the painful experience of financial loss, such as selling stocks or refraining from purchasing even when prices are low.
2. ‘You’ll buy back in next week when it’s lower.’
Many prospective buyers use this excuse to wait for a decline in the stock market. However, investors are always uncertain about the direction in which stocks will move each day, particularly in the short run. The possibility of a stock or market rising or falling next week is equally likely. Numerous experienced investors opt to purchase undervalued stocks and retain them for an extended period.
This behavior is motivated by either fear or greed. The investor driven by fear is concerned that the stock will decline before next week and chooses to wait. On the other hand, the investor driven by greed anticipates a decline but aims to secure a significantly lower price compared to the current one.
3. ‘Your bored of this stock, so your selling.’
Investors who crave excitement in their investments, similar to the thrill of a casino, often use this excuse. However, it is important to note that intelligent investing can actually be dull. The most successful investors understand the value of staying invested in stocks for extended periods, allowing their gains to compound. Investing is usually not a rapid, high-yield game. The profits primarily accumulate during the waiting period, rather than when constantly entering and exiting the market.
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If you want to earn money from stocks, there is no need to constantly speculate on the short-term fluctuations of individual company stocks. In fact, even renowned investors like Warren Buffett advise individuals to invest in affordable index funds and retain them for several years or decades until they require their funds.
The key to successful investing, which has been proven effective, is not very exciting. All it takes is the virtue of patience, as diversified investments such as index funds will eventually yield profits in the long run. Avoid the temptation to pursue the latest trendy stock.
