Whether actively or not, most of us invest in the stock market in some capacity. If you don’t invest yourself, your retirement account probably does. For teens, getting an early start in the stock market is the best way to ensure you retire with a lot of money. Getting started when you’re young allows you to take full advantage of compounding interest, the best form of passive income. So what is the stock market, and what is the best way to make money through investing in it?
Introduction to the Stock Market
What is the Stock Market?
The stock market is the intangible market in which, well, stocks are traded. Stocks are also known as equity, or shares of a company. When you buy shares of a company, you become a part owner of that company. As the company grows and demand for their stock increases, the price of a share of that company increases. This is the most common way to make money in the stock market, which is known as capital gains.
In the United States, the New York Stock Exchange (NYSE) is the largest stock exchange. Shares of roughly 2,800 companies are traded on the NYSE. Like with any commodity, supply and demand is what determines the price of stocks. If a company sells more shares (increases supply), the price of each existing shares goes down. If demand for shares of that company increases, the price per share will increase because investors are willing to pay more to own part of the company.
How to Start Investing
The good news about modern technology is that it has never been easier for anyone to start investing in the stock market. All it takes is downloading any of a number of free apps- Robinhood, M1 Finance, Fidelity, TD Ameritrade, and many others. When picking a service, it is important to choose one that doesn’t charge fees for each transaction. When you first start investing, you likely won’t be starting with a lot of money, so you don’t want to be paying fees and taking away from the amount of money you can invest.
After connecting your bank account to your investing app, it’s time to get started. The hardest thing about beginning to invest is deciding what companies to invest in. While there are many different investment strategies out there, a common one for beginners is to stick to things you know. Companies like Facebook, Apple, Microsoft, and Nike are companies that the average person sees, understands, and uses often. They are established companies (known as “blue chip”) who likely aren’t going bankrupt anytime soon. So, while you are learning how to pick stocks to invest in, it might not be a bad idea to first invest in blue chip stocks and get your money growing in the meantime.
Note: These companies are not named as investment advice. They were simply chosen as examples of blue chip stocks. For full disclosure, I don’t own shares of any of these companies.
Making Money in the Stock Market
What many people don’t realize about the stock market is that it’s actually quite easy to make money. The S&P 500, an index which tracks the performance of the 500 largest companies on the NYSE, has produced an average annual return of just under 10% since its inception in 1926 (between 7-8% when adjusted for inflation. Sure, the market is way different now than it was even five years ago. And sure, there will be ups and downs. Some years, the S&P 500 will have negative returns. This brings us to what should be the biggest takeaway from this post: to make money in the stock market you should invest for the long term. Simply buying stocks, continuing to buy every time you get paid, and holding for 5, 10, 15, 30 years will pretty much guarantee that you’ll make money on your investments.
So how do people lose money in the stock market? Easy. They think for the short term. They invest with their emotions instead of their brain. When stocks prices go down, people get scared and sell. Selling stocks when they are down is a good way to lose money. There are two main reasons that people end up losing money in the stock market: panic selling and fear of missing out.
The current economic situation with the coronavirus pandemic is a perfect time to talk about panic selling. Here’s how it works. Investors see stock prices going down. They panic, thinking that stocks will continue to go down, and sell their shares. Even though investors know the age old strategy of “buy low, sell high,” they can’t keep their emotions out of their investing.
Instead of panic selling, something known as dollar cost averaging is a good way to take advantage of a market crash. Dollar cost averaging is simply continuing to invest a set amount of money into a company at regular intervals. If the company is doing well and shares are up, you might only get 100 shares. But during a market crash, when stock prices are down, that same amount of money might get you 140 shares. This is an investing strategy used to eliminate the risk of buying a large amount of shares all at once at one price.
Here’s another way to think about it. If the price of a stock goes down for whatever reason, does that change the way you view the future of that company? If it does, then yeah, maybe it is time to sell. But let’s say there’s a stock currently trading at $125 per share and you’re confident it will hit $200 per share in the future. A market downturn drives the stock price down to $75, but nothing really changed with the company. It’s the same company with the same goals and you still think it’s a $200 stock in the future. Why would you panic and sell it at $75 per share, rather than buy it at such a great discount? If it’s a good company, the stock price will bounce back every time.
Fear of Missing Out
Fear of missing out (FOMO) is just the opposite of panic selling. Rather than selling low, fear of missing out is buying shares when they are high. Investors see stocks taking off, and they get scared they’ll miss out on the gains. So, they decide to buy into the stock after it is up 15% in a week. Stock prices don’t increase in a linear fashion, though, and the stock goes back down 8% the next week. The investor’s fear of missing out on the gains resulted in them losing 8% in a week.
Instead of getting FOMO and losing money, we go back to dollar cost averaging. It’s just such an easy way to reduce risk in the stocks you buy. Sometimes you’ll be buying low, sometimes you’ll be buying high. But these differences in price balance out in the long run and as the stock price goes up, more money goes to you.
The problem with both panic selling and FOMO is that they are done by investors who are trying to time the market. No one can time the market. Not robots, not your finance professor, not the most successful investors in the world. Trying to time the market is a good way to lose money. Instead of timing the market, focus on your “time in the market.” The more time you spend in the market, the more money you will make.
Investing in the stock market isn’t hard, but many people make it out to be. The easiest strategy is just buy, buy, and buy. Don’t sell at a loss, unless you truly feel the company will go bankrupt and it’s time to cut your losses. Don’t fall into the trap of seeing a stock price fall and immediately selling it. These small losses add up over time. If you’re invested in good companies, stock prices will go back up. Learning to deal with and accept short term losses is one of the best ways to make long term gains. It’s all in the mindset.