One way to financial stability is investing in stocks. It can be the primary route to building long-term wealth since stocks generally increase in value over time.
However, it can be a risky venture since it is impossible to accurately predict the daily fluctuations every time. The infamous Wall Street crash of 2008 serves as a reminder of just how unpredictable the stock market is.
Given the substantial risk that comes with investing in stocks, how exactly does one make money via stocks? Here are a few practices that can enable the growth of your long-term wealth:
An excellent slogan when it comes to investing in stock is “time in the market beats timing the market.” It confers the cardinal rule of where your attention should be—holding the stocks. Instead of trading frequently as soon as your stock prices spike, you should undertake a buy-and-hold strategy.
The numbers also point to the fact that investors who hold their stock over the long term have, on average, significantly higher monthly returns in comparison to their frequently-trading counterparts.
Looking at the 2017 numbers on returns compiled by Putnam Investments, investors gained a average annualized return of 9.9% if they stayed with the company for 15 years. This is because they availed all the best days of the market.
Funds as a financial investment
Individual stocks are generally profitable in the long run. But mutual funds can be better investment avenues for the average investor due to the risk mitigation gained from diversification. If you are putting all money into only one type of investment, you lose out on diversification.
By pooling together their resources in a mutual fund, investors can take advantage of the collective buying power. Plus, you’re paying a small percentage for the expertise of the portfolio manager(s) responsible for the fund’s performance.
While there is greater growth potential investing in individual stocks like Apple or Tesla, there is also greater risk. While the company you choose could eventually go bankrupt, the odds of something catastrophic happening to all of the companies that make up a mutual fund is utterly negligible.
Don’t withdraw dividends
As a new investor, it may be tempting to cash out your dividends as a type of “bonus.” Unless you are desperate for the cash, it is a good rule to not withdraw your dividend earnings as soon as they are released. Yes, you invested your money and yes, it is tempting to reap the benefits, but reinvesting your dividends will result in more growth over the long term. While dividends are not generally huge amounts, they can make a tangible difference to your return over time.
Your brokerage platform will likely default you to have your dividends reinvested instead of being paid out. They may even recommend that you reinvest your dividends, even though you are not charged brokerage/transaction fees for it.
The right accounts
Many first time investors are led to believe that if they’re not investing a large portion of their savings in the stock market, then they’re “missing out.” While there may be some truth to that, exercise caution and time-tested investment advice. The kinds of investments you choose are crucial in ensuring that your long-term investments are profitable.
First, choose a reasonable amount relative to your overall savings. Especially if you’re investing in individual stocks, do not invest any more than you’re ok possible losing. Second, pick the right investment accounts for your goals. Some accounts come with perks like tax deductions or even tax-free withdrawals. You can imagine the immense benefit of that! Over time, this will save you a substantial amount of money in taxes.
If you are choosing a tax-free retirement account for your investment, you must keep in mind that these accounts come with certain conditions. If you attempt to withdraw before retirement age (as defined by the IRS), you may be subject to tax liability, plus a hefty 10% tax penalty! There are certain, limited, scenarios in which you may not be subject to the penalty, but be careful nonetheless.
Taxable and non-taxable accounts
Taxable investment accounts don’t bring you the advantage of storing your money and increasing its value by keeping it free from tax cuts. However, these accounts let you withdraw your money when you see fit. This is certainly more appropriate for short- to mid-term investing.
These accounts enable you to cover up for losses through mechanisms like tax-loss harvesting. Even if you sell stocks at a lower price than where you bought it, you can mitigate the loss by getting a tax break on other income.
If you’re just getting started with investing, consider hiring a professional financial advisor that can guide you through the various types of investment accounts and styles, so you can make wise, educated decisions with your hard-earned money.
Now that you have an idea of some of the basics of stock investing, you can get started with a simple brokerage platform like Robinhood or E*Trade. Brokerage platforms charge a variety of different fees, so do some research before you decide.
It is important to keep in mind that companies’ stocks go up and down all the time. Even the most successful investors recommend starting small and building your portfolio as your income and skill level increase over time. Be especially careful with “fad stocks,” as tempting as they may seem.
Making money with stocks is about knowing your goals and risk tolerance and being patient. However frustrating as it may be, money is made in the long-term. You’ll want to choose the right accounts, reinvest your dividends, and again—be patient. Consider mutual funds as an easy way to diversify your portfolio and mitigate risk.