If you consult any financial expert, you will learn that stocks are essential for constructing enduring prosperity. However, the challenge with stocks lies in their unpredictable day-to-day fluctuations, despite the potential for exponential growth in value over time.
The question that arises is: How can you earn money in stocks? In fact, it is not difficult, as long as you follow established practices and exercise patience.
How to make money in stocks
To begin with, if you are aiming to earn money in stocks, there are some essential things that you must be aware of. Below is a step-by-step guide on how to commence.
1. Pick an investment account
In order to purchase stocks, it is necessary to have an investment account. Much like a bank account, an investment account allows you to deposit money, which can then be used for buying stocks. It’s important to note that an investment account, such as a 401(k), Roth IRA, or traditional brokerage account, is not an investment in itself, but rather a place where your investments are held.
By considering the different types of investment accounts available, you can make a wise choice that may result in significant tax savings. It could be advantageous to possess more than one investment account.
One common suggestion from financial advisors is to begin investing with a 401(k), which is an investment account provided by employers, particularly if there is an employer match available. Afterward, they usually advise individuals to consider investing in either a Roth or traditional IRA to enjoy tax benefits. Lastly, if there are still funds available, advisors recommend considering a traditional brokerage account.
2. Consider index funds
If you are looking to make money in the stock market, there is a simpler alternative to purchasing multiple individual stocks. Index funds consist of numerous stocks that replicate a market index like the S&P 500, making extensive knowledge of individual companies unnecessary for achieving success.
Index funds allow you to invest in multiple stocks simultaneously without the need for individual management. Opting to invest through funds can reduce your risk considerably. For instance, if you have investments in three companies and one of them goes bankrupt, it will likely have a significant impact on your portfolio. However, if you have investments in 500 companies and one of them faces bankruptcy, it is unlikely to have a substantial effect on your overall portfolio.
It is indeed possible to achieve higher returns by investing in individual stocks compared to an index fund. However, in order to attain these returns, substantial effort is required in researching companies. It is important to note that there is a greater likelihood of experiencing financial losses when investing in individual stocks.
3. Buy and hold
Long-term investors often say that being in the market for a long time is more effective than trying to time the market.
To put it simply, one popular method to earn money in stocks is by utilizing a buy-and-hold strategy, which involves holding stocks or other securities for an extended period rather than participating in frequent trading activities.
Do you not believe it? That is important because investors who trade frequently in the market, whether it be daily, weekly, or monthly, have a tendency to overlook chances for substantial yearly profits.
According to Putnam Investments, if you continuously stayed invested in the stock market from the years 2002 to 2017, you would have received an annual return of 9.9%. However, if you engaged in frequent buying and selling, your chances of experiencing these returns were put 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.
Translating to greatly reduced returns, being absent from the market during its most favorable days is evident. Although it may appear simple to ensure investment on those days, it is impossible to predict their occurrence, and instances of significant declines are occasionally succeeded by days of high performance.
To ensure that you take advantage of the stock market when it performs at its best, it is necessary to remain committed for the long term. One way to accomplish this is by implementing a buy and hold strategy, which can also have the added benefit of qualifying you for lower capital gains taxes during tax season.
4. Opt for funds over individual stocks
Experienced investors are aware that diversification, a proven investment strategy, is crucial for minimizing risk and potentially increasing returns in the long run. Consider it as the equivalent of not placing all your eggs in a single basket when it comes to investing.
Although most investors gravitate toward two investment types—individual stocks or stock funds, such as mutual funds or exchange-traded funds (ETF)—experts typically recommend the latter to maximize your diversification.
While you can buy an array of individual stocks to emulate the diversification you find automatically in funds, it can take time, a fair amount of investing savvy and a sizable cash commitment to do that successfully. An individual share of a single stock, for instance, can cost hundreds of dollars.
In contrast, funds allow you to purchase a single share and gain exposure to numerous individual investments, ranging from hundreds to thousands. Although many people desire to invest all their money in companies like Apple (AAPL) or Tesla (TSLA), the truth is that even professionals lack a solid history of accurately predicting which companies will yield significant profits.
That is the reason why professionals suggest that the majority of individuals should invest in funds that passively follow significant indexes such as the S&P 500 or Nasdaq. This ensures that you have the opportunity to profit from the stock market’s average annual returns of around 10% effortlessly and affordably.
5. Reinvest your dividends
A periodic payment based on their earnings is given to the shareholders by many businesses.
Although the dividends you receive may appear insignificant, particularly during the initial stages of investing, they play a significant role in the substantial growth of the stock market throughout history.
From September 1921 to September 2021, the S&P 500 recorded an average annual return of 6.7%. However, if dividends were reinvested, the percentage surged to nearly 11%. The reason behind this is that each reinvested dividend enables the acquisition of additional shares, accelerating the compounding of earnings.
Financial advisors often advise long-term investors to reinvest their dividends instead of using them for immediate expenses due to the advantageous compounding effect. To facilitate this, many brokerage firms offer a dividend reinvestment program, known as DRIP, which allows investors to automatically reinvest their dividends.
Excuses that keep you from making money investing
When the stock market experiences a slight decrease, investors become fearful and sell their assets in a panic, causing a dip in the market. Conversely, when prices rise, investors eagerly jump in. This behavior leads to a common pattern of purchasing assets at high prices and selling them at low prices, resulting in a counterproductive approach to investing.
In order to avoid falling into either of these extremes, investors must comprehend the common deceits they tend to believe. Here are three major ones:
1. ‘You’ll wait until the stock market is safe to invest.’
Investors often employ this excuse when they are hesitant to enter the market after experiencing a decline in stocks. This decline could have occurred over several consecutive days or even over a prolonged period of time.
Investors often express their wait for safety as referring to the wait for prices to rise. Consequently, waiting for (the perception of) safety can lead to paying elevated prices, as investors often solely pay for a perceived sense of safety.
What motivates this behavior is the emotion of fear, but psychologists refer to this particular behavior as “loss aversion.” In other words, investors prefer to avoid a short-term loss at any expense rather than gain in the long run. Therefore, when experiencing discomfort from losing money, individuals are inclined to take any measure to alleviate that pain, 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 potential buyers use this excuse while waiting for the stock price to decrease. However, investors are never certain about the direction of stock movements on any particular day, particularly in the short run. There is an equal chance for a stock or market to rise or fall in the upcoming week. Numerous experienced investors purchase stocks when they are inexpensive and retain them for a prolonged period.
This behavior is driven by either fear or greed. The investor driven by fear is concerned that the stock will decline before the next week and therefore waits. On the other hand, the investor driven by greed anticipates a decline but aims to secure a significantly better price than the present one.
3. ‘Your bored of this stock, so your selling.’
Investors who crave excitement in their investments, similar to the thrill experienced in a casino, often use this excuse. However, smart investors know that engaging in long-term, patient investing can indeed be uneventful. The most successful investors choose to hold onto their stocks for extended periods, allowing their gains to accumulate over time. Generally, investing is not a fast-paced endeavor. The gains materialize during the waiting period, rather than through frequent trading in and out of the market.
The driving force behind this behavior is an investor’s craving for thrill. This craving can be intensified by the incorrect belief that successful investors constantly engage in daily trading to achieve significant profits. Although there are traders who do achieve this, they too are relentlessly and logically concentrated on the end result. Their focus is not on excitement, but rather on making money, which is why they steer clear of making emotional decisions.
