By William Sun
Overview
“Nobody knows if a stock is going to go up, down, sideways or in circles.” This is a quote from Mark Hanna from the movie, The Wolf of Wall Street. Starring top-tier actors such as Leonardo DiCaprio and Margot Robbie, this 2013 movie portrayed the stock market as a drug-fueled, corrupt, unpredictable, and aggressive economic industry. The various stock traders in the movie, including DiCaprio himself, are greedy and dishonest.
In real life, however, getting into the stock market can be much simpler. Investing in stocks can be a great way of making money in the long run, as long as it's done right.
What are stocks and why should you invest in them?
Stocks are defined as securities that constitute partial ownership of a corporation or company. Together, many units of stocks are called “shares,” giving the owner a part of the company's assets and profits proportional to the number of stocks owned.
In a much simpler definition, stocks are simply owning a small part of a company, giving you access to the profits, assets, and money that the company makes. At the same time, as with all real-life businesses, stocks can also cause the owners to lose money if the company starts to struggle.
But why invest in stocks in the first place if there's the possibility of losing money? When done carefully stocks can bring a host of long-term positive effects!
Grow with the economy: Investing in stocks provides a unique opportunity to make money that grows with the economy. Since you have partial ownership of a company, the dynamic and developing economy leads directly to corporate growth. In times of great economic growth (not right now though!), you could gain huge profits in short periods when the company you invested in also grows.
Allows you to stay ahead of inflation: With inflation currently raging in the economy, with the rate being a whopping 8.5% [1], it's more important than ever to stay ahead of increasing prices and decreasing values. Stocks are a great way to fend off inflation and make money in the long term. While dropping values may cause a loss of money in the short term, over a longer period of time, stocks give a significant return (% of the increase in stocks value). In fact, the annual return for the S&P500, a benchmark for American stocks, was 11%, greater than the inflation rate.
Instant profit through liquidity: One unique feature of the stock market is that stocks can be sold at any time, allowing you to make some quick cash at any time. With a clear understanding of the stock market and the company you’re investing in, the liquidity of stocks allows you to pull your money out instantaneously, preventing significant loss. Ultimately, compared to other long-term assets such as real estate, stocks are much more flexible and easy to sell at any time.
Dividends: Apart from the long-term return of stocks, stocks also provide continuous passive income that can add to your monthly income. 53% of global stocks (2) pay quarterly or monthly dividends, which are a portion of the profits. This additional profit from stocks makes them a great addition to your portfolio.
How to safely and effectively invest in stocks?
However, stocks aren’t purely beneficial. If you have heard of the Great Depression (a major economic crash in the US economy in the 1930s), then you may understand how volatile, unpredictable, and even dangerous the stock market can be. Luckily, there are thousands of resources to help you safely navigate the stock market. Here is how to get started! (3)
Choose a method of investment: Taking into account your own financial expertise and situation, different methods of investing may be right for you. Hiring someone else to help manage and buy your stocks for you may be good for those with more money and less experience; however, the costs of hiring such a manager ($2,000 to 7,500 per year) (4) may be too much. On the other hand, employing an automated advisor and manager is much cheaper than a real human while potentially lacking the skills needed to manage the stocks in hard times. For those with more experience in investing, simply buying the stocks yourself is a great option.
Create the right investment account: Depending on how you invest, different accounts are needed to begin. Having a human or robot advisor requires much less work as they simply design and lay out the portfolio for you based on your desires. Doing it yourself, though, mandates making a brokerage account, which can allow you to buy all kinds of other investments such as bonds and provides additional education. Some of these broker accounts include Fidelity Investments, TD Ameritrade, and E-trade Financial. Taking the time to carefully research these accounts to see if they match your investment budget, preference, and abilities are critical for getting off on the right foot.
Decide on the right investment and how much to invest: With a human or robot advisor, selecting the right investments is very streamlined, as there is typically a set of questions, interviews, and discussions that help optimize your investment. Some of these questions center around your risk tolerance and when exactly you want your money back. On your own, you have to consider the myriad of different stocks, including common shares, individual stocks, and stock funds. Moreover, you must choose whether to invest more passively or actively.
Considering how variable stocks can become, multiple steps can be taken to avoid losing a significant amount of money.
Understand the market: Having a thorough understanding of all the ups and downs of the stock market and the general direction of the economy is extremely helpful in avoiding losing money. In particular, analyzing the business cycle and its phases helps you choose the best time to start investing. While it may be better to buy stocks during the expansion phase when the economy and the GDP are growing, it is better to avoid such investments when the economy endures a contraction- where the economy shrinks, employees are laid off, and prices decline.
Diversify your investment: Having a variety of stocks from different industries, markets, and fields contributes to a more stable and resilient portfolio in the face of an economic downturn. Investing in just one industry, especially such as the lucrative cryptocurrency market, can be harmful to economic contractions. Instead, by expanding your portfolio and including a diverse set of stocks, including different types, the losses can be minimized, while the profits are maximized.
Stay committed: While the volatility of the stock market, and the endless discussions of inflation, new markets, and prices, may deter you from selling stocks and switching plans, sticking to your original stocks and plans can project huge future returns. Accepting that there will inevitably be some loss in this process is critical to making significant long-term returns. Having an advisor or even a friend or family member to help encourage and guide you through this process could be a great way to stay focused and determined.
Invest often, not much: Research has found that investing frequently in smaller amounts leads to larger long-term returns than investing in huge lumps at once. Not only does investing regularly allow you to adapt and change to the changing market conditions, but investing more often can allow you to address the peaks and troughs of the stock market through Pound Cost Averaging.
What should I watch out for when investing in stocks?
To prevent crashing and losing a lot of money, several practices and red flags should be avoided.
Speculation: One of the biggest issues plaguing the stock market, speculation is a pitfall that actually even contributed to the infamous stock crash that drove the Great Depression. Specifically, speculation involves making more risky investments based on different price fluctuations in the markets. Appealing to high-risk and high-reward outputs, this strategy includes new industry stocks, pharmaceutical stocks, and raw materials stocks. While speculation can give high profits, the risks of these smaller, lesser-known companies are greater than established, regulated multi-level corporations. Be careful of the notion that risks will always equal more money.
Following trends: The media these days often promote new products, stocks, and assets that are portrayed to be extremely valuable. Take great care to take the time to research to avoid the following misinformation and pursuing unstable trends. For example, while hypothetical “vast oil fields” and “cures for cancers” may seem like an excellent investment, without the proper research and analysis of whether these companies are actually viable, investing in these stocks could be disastrous. Furthermore, trying to “time” the market (making financial decisions based on projections of future market fluctuations) often gives fewer returns than consistently investing.
Unethical stocks: Many companies often use unethical business practices, whether it be using horrendous child labor systems and treating their employees terribly to simply selling “bad” products such as tobacco, fossil fuels, and alcohol. Not only does your own moral compass come into play, but these companies are often less stable, subject to whatever lawsuits and other consequences that could drop the value of their stocks. Ultimately, remember that the profit you make from these stocks comes from the exploitation of children, families, and employees.
Reckless and Impatient thinking: Among all shareholders, having the wrong mindset is one of the most detrimental things to getting returns. Constantly making risky moves, trading and selling stocks, buying stocks for high prices, and then selling low for quick returns are all indications of an impatient mindset. Having patience and commitment is absolutely necessary for getting long-term returns. Moreover, letting your emotions overrun your decisions, whether it be preferences for a company, familial situations, or even just a bad day, is harmful. As always, having an advisor or a family member keep you in check throughout the investment process is helpful!