The way the stock market works â and works for you â is as simple as a high school economics class. Itâs all about supply and demand, and the way those factors affect value.
Investors purchase market assets like stocks (shares of companies), which increase in value when the company does well. As the company in question makes financial progress, more investors want a piece of the action, and theyâre willing to pay more for an individual share.
That means that the share you paid for has now increased in price, thanks to higher demand â which in turn means you can earn something when it comes time to sell it. (Of course, itâs also possible for stocks and other market holdings to decrease in value, which is why thereâs no such thing as a risk-free investment.)
Along with the profit you can make by selling stocks, you can also earn shareholder dividends, or portions of the companyâs earnings. Cash dividends are usually paid on a quarterly basis, but you might also earn dividends in the form of additional shares of stock.
Micro-mechanics of how stocks earn money aside, you likely wonât see serious growth without heeding some basic market principles and best practices. Hereâs how to ensure your portfolio will do as much work for you as possible.
Although itâs possible to make money on the stock market in the short term, the real earning potential comes from the compound interest you earn on long-term holdings. As your assets increase in value, the total amount of money in your account grows, making room for even more capital gains. Thatâs how stock market earnings increase over time exponentially.
But in order to best take advantage of that exponential growth, you need to start building your portfolio as early as possible. Ideally, youâll want to start investing as soon as youâre earning an income â perhaps by taking advantage of a company-sponsored 401(k) plan.
To see exactly how much time can affect your nest egg, letâs look at an example. Say you stashed $1,000 in your retirement account at age 20, with plans to hang up your working hat at age 70. Even if you put nothing else into the account, youâd have over $18,000 to look forward to after 50 years of growth, assuming a relatively modest 6% interest rate. But if you waited until you were 60 to make that initial deposit, youâd earn less than $800 through compound interest â which is why itâs so much harder to save for retirement if you donât start early. Plus, all that extra cash comes at no additional effort on your part. It just requires time â so go ahead and get started!
Time is an important component of your overall portfolio growth. But even decades of compounding returns can only do so much if you donât continue to save.
Letâs go back to our retirement example above. Only this time, instead of making a $1,000 deposit and forgetting about it, letâs say you contributed $1,000 a year â which comes out to less than $20 per week.
If you started making those annual contributions at age 20, youâd have saved about $325,000 by the time you celebrated your 70th birthday. Even if you waited until 60 to start saving, youâd wind up with about $15,000 â a far cry from the measly $1,800 youâd take out if you only made the initial deposit.
Making regular contributions doesnât have to take much effort; you can easily automate the process through your 401(k) or brokerage account, depositing a set amount each week or pay period.
If youâre looking to see healthy returns on your stock market investments, just remember â youâre playing the long game.
For one thing, short-term trading lacks the tax benefits you can glean from holding onto your investments for longer. If you sell a stock before owning it for a full year, youâll pay a higher tax rate than you would on long-term capital gains â that is, stocks youâve held for more than a year.
While there are certain situations that do call for taking a look at your holdings, for the most part, even serious market dips reverse themselves in time. In fact, these bearish blips are regular, expected events, according to Malik S. Lee, CFPÂŽ and founder of Atlanta-based Felton & Peel Wealth Management.
So-called market corrections are healthy, he said. âIt shows that the market is alive and well.â And even taking major recessions into account, the marketâs performance has had an overall upward trend over the past hundred years.
All investing carries risk; itâs possible for some of the companies you invest in to underperform or even fold entirely. But if you diversify your portfolio, youâll be safeguarded against losing all of your assets when investments donât go as planned.
By ensuring youâre invested in many different types of securities, youâll be better prepared to weather stock market corrections. Itâs unlikely that all industries and companies will suffer equally or succeed at the same level, so you can hedge your bets by buying some of everything.
Although the internet makes it relatively easy to create a well-researched DIY stock portfolio, if youâre still hesitant to put your money in the market, hiring an investment advisor can help. Even though the use of a professional canât mitigate all risk of losses, you might feel more comfortable knowing you have an expert in your corner.
Given the right combination of time, contribution regularity and a little bit of luck, the stock market has the potential to turn even a modest savings into an appreciable nest egg.
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