The reason for investing in stocks is to attain financial security. While some people may make a spectacular investment decision by chance, the vast majority who succeed at investing in stocks save their money and invest over a long period of time. Success in investing starts with defining your goals. What do you want to get out of investing? Make a list with the most important goals like having enough money for retirement, putting your children through college, or saving up to start your own business at the top of the list. Then consider how many years are left for you to attain each of these goals. The point is that your choice of investments needs to fit the available time frame.
The best returns on investment over the years come from routine stock investments.
Investing in Stocks
Investing in stocks needs to be part of your total financial strategy. Before you start putting money into the stock market, pay off your credit card debt. A typical interest rate on credit card debt is 24% per year. You are not likely to get this rate of return as a novice investor, so pay off your credit cards before investing in stocks. And, put three months-worth of expenses in the bank so that you are not continually selling your stocks to cover routine living expenses! Now you are ready to consider how to invest.
Investing in Stocks vs Bonds
For those who have heard the horror stories of folks losing everything in the 2008 stock market crash and financial crisis, how to invest without losing any money is a major issue. As we note in our article about investing and not losing money, a portion of your investment portfolio should be conservative. A simple way to do this is to purchase certificates of deposit at your bank. These are protected against loss up to $250,000 per depositor per bank by the Federal Deposit Insurance Corporation, an agency of the U.S. government.
Alternatively, U.S. Treasuries are backed by the “full faith and credit” of the U.S. government and will not result in any losses if held to maturity. The next conservative investment in line is an AAA corporate bond. The two U.S. corporations with this bond rating are Microsoft and Johnson & Johnson.
But, in order to attain your goals you probably need to get a larger return on investment than with these conservative vehicles. Over the years, stocks have offered the most potential for growth.
This brings us to the mechanics of investing stocks. The best approach according to most experts is to allocate a set amount of money with each paycheck, every quarter or annually as money becomes available. Then, which is best, investing in stocks now or later, investing in stocks with dividends, letting a mutual fund do your investing for you, putting your money in index funds, or simply investing in stocks online by yourself.
Investing in Stocks Now
Once you have put your financial house in order it is time to invest in stocks. When you invest early in life you get to take advantage of the exponential growth of wise investments. The rationale is that a well-chosen investment in the stock market may appreciate as much as 12% a year on the average. When you leave this investment in place you benefit from the “rule of 72.” Divide the number 72 by your average yearly percent return on an investment. This gives you the number of years required to double that investment!
With a common stock whose appreciation plus dividends come to 12% on the average it will take six years to double your money. Start investing in stocks now when you are 25 years old and you will have seven x six = 42 years until you reach age 67. Double your investment seven times and you will get a 2x2x2x2x2x2x2=128 fold appreciation on your initial investment! The $100 that you invest in a well-chosen stock at age 25 could be worth 128 x $100 = $12,800 and that is just the $100 that you invested in one month.
The basic reason that investing in stocks builds wealth better over the long term is that with stocks you get more “doublings” over the years when you start early and continue over the years.
Investing in Stocks with Dividends
In our article about dividend stocks, we note that some companies have routinely paid dividends for more than a century. Not only is such an accomplishment an indication of the safety of such investments but when dividends are reinvested and added to the usual stock appreciation it makes “rule 72” work faster! Look for companies with dividend reinvestment plans when considering dividend stocks.
Investing in Stocks vs Index Funds
Although we would like to think we can pick the best investments, even experienced fund managers can have a hard time beating the S&P 500 over the years. As such, many investors choose a fund that tracks a major stock index like the S&P 500 or a sub-category of the S&P 500 such as consumer staples, consumer discretionary, energy, communication services, financials, health care, industrials, materials, information technology, real estate, and utilities. And, there are many sub-sectors within each of these categories as well. We commonly suggest that if you are picking your own investments that you should start with things that you know about as your knowledge and insights will give you an advantage over other investors.
Investing in Stocks Short Term vs Long Term
Short term investing requires skill at market timing. Basically, you need to recognize an opportunity early in the game, make your investment, and then sell when the stock reaches a plateau or starts to fade. There are investors whose only method of investing in stocks is this approach. While some of these folks do very well, many routinely lose money chasing an elusive dream. When an investor repeatedly buys and sells stocks he or she incurs a cost with every transaction. Fees and commissions can eat up what would otherwise be moderate profits. This is the main reason why old, rich investing legends like Warren Buffett do not try to time the market. Rather they look for long term value and unique buying opportunities.
Long term investors know that the eventual price of a stock is determined by its intrinsic stock value. This is the value of the stock based on its projected future earnings. Successful long term investors only invest in stocks when they clearly understand how the company makes money and how their business plan will result in continued earnings into the distant future. Carrying this approach to success requires a bit of homework and patience. Imitating the investment portfolios of the most successful investors like Buffett is a place to start. Buffett himself has said that as he and his team look for clear indications of strong intrinsic stock value they end up throwing out 19 out of 20 possible investments.
The best way to start with this method is by imitation of successful investors and then add more investments of your own as you gain experience. A key factor is to keep track of what you have in your portfolio and use the intrinsic value calculation contained in our article to not only decide what to buy when investing in stocks but what to unload when the company’s business plan is no longer working!
Investing in Stocks vs Mutual Funds
Many folks have the money and want to save and invest for retirement, sending the kids to college, or being able to afford to live the life they always dreamed. These same folks may well be too busy with their work and their lives to devote sufficient time and effort to making and following their investments with the degree of skill and attention that they deserve. Many of these folks will look for someone to invest for them. One approach is a mutual fund. Fidelity explains what a mutual fund is.
Mutual funds are investments that pool your money together with other investors to purchase shares of a collection of stocks, bonds, or other securities, referred to as a portfolio, that might be difficult to recreate on your own. Mutual funds are typically overseen by a portfolio manager.
There are several advantages to investing in a mutual fund instead of directly investing in stocks. First of all, stocks like Amazon.com sell for more than $1,700 a share and shares of Warren Buffett’s Berkshire Hathaway Class A stock sell for more than $300,000 a share! These are good investments and anyone who is routinely investing $100 a month cannot buy a single share. But, a mutual fund can and they do. A well-managed mutual fund invests in a range of stocks, bonds, and other investments to provide a good return on investment for the investors in the fund.
The “downsides” to investing in a mutual fund are two. The investor pays a fee to have his or her money “managed” by the fund. And, all too often, a mutual fund does not outperform an index fund that tracks the S&P 500! But, if you do not have the time and energy to do your own investing in stocks, consider a well-managed mutual fund with low fees or simply put your money into an index fund that tracks the S&P 500.
Investing in Stocks Online
For many investors, the old days of going through a traditional stockbroker for investing in stocks are gone. Today many if not most investors use an online stock broker. A good online broker offers research capabilities and often does not require an account minimum and does not charge annual fees like a mutual fund would. Popular online brokers include Vanguard, E-Trade, Fidelity, Charles Schwab, Ameritrade, and Merrill Edge. The same principles apply to investing in stocks online as to investing through a broker. On one hand, you will not be sold a “bill of goods” on a stock by a broker who is “pushing” it this week, which is a good thing. And, on the other hand, you will not have a wise old investment pro to guide you towards good investment choices and away from bad ones either.
Is Investing in Stocks Worth It?
Some folks will read this article and think that investing in stocks sounds like a lot of work. They will rightfully wonder if it is worth it to invest in stocks rather than simply putting their money in U.S. Treasuries or CDs in their bank. The truth of the matter is that if you are building an investment portfolio for retirement, to start your own business, to pay for college, and to live the life of your dreams, you need a balanced investment portfolio.
This means putting some money in the bank, building a ladder of CDs, purchasing US treasuries and AA corporate bonds, and investing in stocks. Always remember that you need to balance safety with the power to grow your investments. However, the “rule of 7” works best for well-chosen stocks. If you are not up to the challenge of picking your own individual stocks due to time constraints, go with index funds or swallow hard and pick a mutual fund.