Everyone knows who Warren Buffett is, even those who do not invest a dime in the…
Can you make money in the stock market? Or is it all just one big gambling scheme? The short and unequivocal answer is: yes can make money in the stock market. Otherwise, happenings at the New York Stock Exchange won’t make any difference on day-to-day economic events. You may have already learned from history that stock investment has been the more productive way to park your money compared to, for instance, bond investment. Even with a very volatile stock market or amidst a period of recession, the market continues to lure investors.
Average Return of Stocks
The S&P 500, a more commonly monitored equity index than the Dow Jones Industrial Average or the Nasdaq, has returned an annual simple average rate of 11.1 percent in the past 50 years. The average returns for the last 40, 30, and 20 years are 11.27, 12.15, and 9.89 percent, respectively. These returns are higher than other forms of investment like Treasury bills and bonds. The average return of 10-year Treasury bonds for the half-century was 5.38 percent while Treasury bills’ was 3.61 percent. Even during the past decade when the worst recession since the Great Depression happened, the S&P 500 managed to return 8.71 percent annually on the average.
Stocks versus Bonds
Stocks are historically more volatile than bonds. This is the reason why a risk-averse investor would prefer bonds over stocks. But an analysis of the performance of stock prices and bonds over the years shows that returns on stocks are higher than that of bonds. Comparing the rolling 25-year returns of S&P 500, an index for stocks, with that of the Barclay Aggregate Bond Index from 1925 to 2011, the median return from stocks was 11.4 percent, higher than the 4.3 percent median return of bonds. In fact, in all the 25-year periods, stocks have outperformed bonds up to 10 percent or more.
Below is a chart of the average of the Dow Jones Industrial sine 1900:
The Dow Jones average rose from just 69 pts to well over 15,000 points in 2013—that’s 230 times the average in 1900, far surpassing inflation rate during the same timespan.
Long-term versus Short-term Stock Investing
You would learn from history that stock investing, either for long-term or short-term, is a profitable investment. Those who make money from the stock market in the short run usually opt for growth stocks which have the ability to return huge profits over a short period of time. On the other hand, long-term investors go for undervalued stocks that have sound fundamentals which the market has not fully tapped yet. They gain when these stocks eventually realize their intrinsic values.
Choosing between investing for short-term or long-term depends on an investor’s objectives, the corresponding time horizon for these objectives and the risk appetite. Others do combine short-term with long-term investment. The tax consequences of investments are the main reasons why there are investors who prefer long-term over short-term. The tax rates on capital gains from long-term investment are lower than those imposed on regular income. It is a way to encourage investments and entrepreneurship in the economy. On the other hand, long-term investment exposes an investor to a lot of risks. Stock market crashes, for instance, provide lessons that any investors cannot simply put on the back burner. Moreover, there is also the possibility that whatever gains a stock promises to deliver, these can be offset by high inflation.
Risks and Returns
In stock investing, as with anything else, high returns do come with high risks. If you are too frail to take in the steep fluctuations of stock prices, you better get yourself a low-risk investment option like government bonds. But you have to know that these give out very low returns, too. However, if you are willing to swallow the risk of losing your money overnight, then you are in for huge returns as well. You don’t have to choose between no risk and all risk though for you can always choose to create a balanced mix of these two types of investments, one that you can peacefully take.
Making Money from Dividend Payouts
Aside from price appreciation, another important way for investors to make money in the stock market is through dividend payments. Investors profit from the safe and rising dividend payouts from stocks that have good dividend records. This is actually a critical part in stock investing. Did you know that dividends actually comprise 42 percent of the stock market returns for the last 83 years?
Therefore, if you want to earn from the dividend payments of companies, you have to do long term stock investing. You can even gain much more if you reinvest the income you earn from dividends. Dividend investing was said to cater the needs of older investors but given the huge prospects from dividends, there is no reason why younger investors should not go for it as well. It is for everybody who wants to make money but who is willing to give it enough time to transpire.
Mutual Funds and Exchange-Traded Funds
If you are an investor who doesn’t have all the time and knowledge to closely guard your investment portfolio, investing in index funds is an easy way to participate in the stock market. Considered as a type of passive investing, index mutual funds provide a broad exposure with minimal costs. It is likewise tax efficient. You can get mutual funds from vendors such as Vanguard, T. Rowe Price, or Fidelity Investments. Apart from mutual funds, you can also invest in an exchange-traded fund or ETF. ETF is a security that trails an index like the S&P 500 but trades like a stock. You also get the same benefits you get from a broad range of stocks. A known example of ETF is the Spider or SPDR which trades under the SPY symbol.
The stock market is a place where many people can profit and lose at the same time. But so far, the net returns have been positive and are larger than other investment options. One of the attractive points of stock investing is the safety that dividend income brings. Hence, investors tend to hold on to their stocks portfolio on the long-term. Meanwhile, some investors who make wise short-term decisions also make money from investing in the stock market. The idea is as long as you do your homework and execute your investment activities well and at the right timing, the stock market can be worth the risks.
So if you are ready to start investing in the stock market, check out our list of the top 10 online stock trading sites to get started!