Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but this does not affect the opinions or ratings of our editors.
Ask any financial expert and you will hear that stocks are one of the keys to building long term wealth. But the tricky part about stocks is that while over the years their value may grow exponentially, their day-to-day movement is impossible to predict with complete accuracy.
Which begs the question: How can you make money in stocks?
In fact, it is not difficult, as long as you adhere to some proven practices and be patient.
1. Buy and hold
There is a common saying among long-term investors: âTime in the market beats the pace of the market. “
What does it mean? In short, a common way to make money in stocks is to adopt a buy and hold strategy, in which you hold stocks or other securities for a long period of time instead of engaging in purchases and frequent sales (i.e. trading).
This is important because investors who regularly trade the market on a daily, weekly, or monthly basis tend to miss out on opportunities for high annual returns. You do not believe it ?
Consider this: The stock market returned 9.9% per year to those who remained fully invested in the 15 years up to 2017, according to Putnam Investments. But, if you enter and exit the market, you are jeopardizing your chances of seeing those returns.
- For investors who only missed the best 10 days of that time frame, their annual return was only 5%.
- The annual return was only 2% for those who missed the best 20 days.
- Missing the best 30 days actually resulted in an average loss of -0.4% per year.
Obviously, being out of the market on the best days results in significantly lower returns. While it may seem like the easiest solution is to just always make sure you’re invested on those days, it’s impossible to predict when they will be, and days of strong performance sometimes follow days of strong. drops.
This means that you need to stay invested for the long term to ensure that you are getting the most out of the stock market. Adopting a buy and hold strategy can help you achieve this goal. (And, what’s more, it helps you come up to tax time by qualifying for lower capital gains taxes.)
2. Go for funds rather than individual stocks
Seasoned investors know that a proven investment practice called diversification is key to reducing risk and potentially increasing returns over time. Think of it as the investment equivalent of not putting all of your eggs in one basket.
Although most investors look to two types of investing – individual stocks or equity funds, such as mutual funds or exchange-traded funds (ETFs) – experts generally recommend the latter. to maximize your diversification.
While you can buy a range of individual stocks to mimic the diversification you automatically find in funds, it can take time, a fair amount of investment, and a large cash commitment to achieve this successfully. An individual action of a single action, for example, can cost hundreds of dollars.
Funds, on the other hand, allow you to buy exposure to hundreds (or thousands) of individual investments with a single share. While everyone wants to invest all of their money in the next Apple (AAPL) or Tesla (TSLA), the simple fact is that most investors, including professionals, don’t have a solid track record in predicting which companies will generate. disproportionate returns. .
That’s why experts recommend that most people invest in funds that passively track major indices, like the S&P 500 or the Nasdaq. This allows you to benefit from the average annual returns of around 10% of the stock market as easily (and cheaply) as possible.
3. Reinvest your dividends
Many companies pay their shareholders a dividend, a periodic payment based on their profits.
While the small amounts you receive in dividends may seem negligible, especially when you first start investing, they are responsible for much of the historical growth of the stock market. From September 1921 to September 2021, the S&P 500 posted average annual returns of 6.7%. However, when the dividends were reinvested, that percentage jumped to almost 11%! This is because each dividend you reinvest allows you to buy more shares, which allows your income to accumulate even faster.
This improved mix is ââwhy many financial advisers recommend long-term investors to reinvest their dividends rather than spending them when they receive the payouts. Most brokerage firms give you the option of automatically reinvesting your dividends by signing up for a dividend reinvestment program, or DRIP.
4. Choose the right investment account
While the specific investments you choose are undeniably important to your long-term investment success, the account you choose to hold them in is also crucial.
This is because some investment accounts give you certain tax benefits, like tax deductions now (traditional retirement accounts) or tax-free withdrawals later (Roth). Whichever you choose, both also allow you to avoid paying taxes on any earnings or income you receive while the money is held in the account. This can overload your retirement funds, as you can defer taxes on those positive returns for decades.
These advantages come at a cost, however. You generally cannot withdraw from retirement accounts, such as 401 (k) retirement accounts or individual retirement accounts (IRAs), before age 59 and a half without paying a 10% penalty as well as taxes. that you must.
Of course, there are certain circumstances, like heavy medical bills or dealing with the economic fallout from the Covid-19 pandemic, that allow you to dip into that money without penalty. But the general rule is that once you’ve put your money in a tax-advantaged retirement account, you shouldn’t touch it until you’ve reached retirement age.
Meanwhile, old taxable investment accounts don’t offer the same tax incentives, but allow you to withdraw your money whenever you want, for whatever purpose. This allows you to take advantage of certain strategies, such as harvesting tax losses, which involves turning your losing stocks into winning stocks by selling them at a loss and getting tax relief on some of your gains. You can also deposit an unlimited amount of money into taxable accounts over the course of a year; Both 401 (k) and IRAs have annual caps.
All this to say that you need to invest in the ârightâ account to maximize your returns. Taxable accounts can be a good place to park your investments which typically lose less of their returns on taxes or for the money you need over the next few years or the next decade. Conversely, investments that may lose more of their tax returns or those that you plan to hold for the very long term may be better suited to tax-efficient accounts.
Most (but not all) brokerage firms offer both types of investment accounts, so make sure that the firm of your choice has the type of account you need. If not, or if you’re just starting your investing journey, take a look at Forbes Advisor’s list of top brokers to find the right choice for you.
The bottom line
If you want to make money in stocks, you don’t have to spend your days speculating on individual company stocks that might go up or down in the short term. In fact, even the most successful investors like Warren Buffett recommend that people invest in low cost index funds and hold them for years or decades until they need their money.
The proven key to a successful investment is therefore unfortunately a bit boring. Just have the patience that diversified investments like index funds will pay off in the long run, instead of chasing the latest trending stocks.