How to make money in stocks

How to Make Money in Stocks

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew’s past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC’s Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals» podcast.

Our content is made possible by clients who pay for our smart financial services. Learn more about us here.

The first thing you’ve got to do if you want to make money in stocks is boil down every part of the animal — lips, ears, hooves — everything. Flavor’s flavor! And use a lot of water, because the more water you use, the more stock you end up with.

Oh, sorry, you want to make money in stocks, like equities! Okay, that’s a lot less messy than your grandma’s beef stock.

How to make money in stocks

Here are two statements that are both true. In any given decade, a lot of people have gotten rich investing in the stock market. In any given decade, a lot of people have lost everything investing in the stock market. You’d probably like to figure out a way to be among those in the first sentence. We’ll do what we can to load you up with info, but the first thing you must always remember is that investing in stocks is inherently risky, and no matter how much you know, you’re always at risk of losing some, or even all of your investment.

How to make money in stocks

There are no guarantees that you’ll make money in stocks, since investing always carries a certain degree of risk. However, having a diversified portfolio and not letting yourself get swayed by the ups and downs of the market will usually go a long way in reducing your risk and allowing for growth.

The first cardinal rule of stock market investing is: Do Absolutely Nothing. What do we mean by this? If you invest in the stock market and start paying attention to all the opinions shared on financial news, you’d pull your money out of the market as soon as conditions started looking bad and probably just as quickly when things started looking too good.

Emotions are the enemy of wealth creation. This process of meerkatting in and out of the market is what’s called market timing, and it’s consistently shown to be a losing investment strategy. The quality you need to be a successful investor is what the French call sangfroid — imperturbability in the face of a lot of noise. Money invested in the stock market grows best when left alone in both up and down markets.

Be boring and diversify

The next way to make money in the stock market might seem a bit counterintuitive. Yes, it’s absolutely true that a modest investment in Amazon back in 1997 would probably mean you’d own your own continent now. On the other hand, if you’d put all your money on Snapchat in 2017 or Twitter in 2014, you might be living above your parents garage right about now. Picking individual stocks is a lot like playing the lottery with your life savings.

There happens to be one well-documented method to make money in the stock market without having to pick between the winners and losers. You could buy a whole lot of different ones, like hundreds of them, in hopes that the markets will continuing performing in the future as they have been for the last 100 or so years. Harry Markowitz, a Nobel Prize winning economist, championed an investment strategy called Modern Portfolio Theory that posits that the key to effective investing is diversification. By investing widely, the theory goes, you’ll enjoy robust stock market results while protecting yourself from crushing downside when a specific stock or sector falls precipitously.

See, even as some stocks have risen and others fallen, stocks as a group have risen; in the 1880’s, when it was first created, the Dow Jones Industrial Average stood at 62.76, and despite cataclysmic events like the Great Depression and the recent Global Financial Crisis, it now sits well over 20,000. (Be warned, though— investments are speculative and understand that past results should never be understood to be guarantees, but rather imperfect predictors of future performance.)

Famously rich stock picker Warren Buffett has spent the last decades discouraging pretty much everyone not named Warren Buffet from trying to make money picking individual stocks; he instructs his heirs that when he’s gone, they invest the lion’s share of their inheritance in low-cost market hugging funds. Studies show that diversification, that is, making sure your eggs are divided into a whole bunch of different baskets, as well as allowing for long investment horizons, happens to be a pretty great two-part strategy to counteract the natural volatility of the stock market. Historically, the short-term risk of investing in the S&P 500 dissipated over time.

Fees: The Enemy of Making Money in the Stock Market

Above, we discuss how people often lose money in the market. They bet on a stock or a few stocks, and they bet wrong. Diversification can help counteract that. But the other way to lose money is far more insidious. What if your investment went up in value, but not enough to outpace the drain caused by the fees you’re paying. Which brings us to cardinal rule #2. Keep Fees Low. Fees are basically investment vampires that survive by drinking up all your gains and your job as an investor is to become Abraham Van Helsing, vampire fee killer because studies have shown over and over again that fees are directly predictive of returns in a very simple way; the higher the fees, the lower the returns.

As luck would have it, the same strategy that allows you to diversify also allows you to keep your fees low. Index funds and many ETFs represent what’s called “passive investing,” a term that means that no human is involved in managing the investment. In many cases, a computer algorithm allows the passive investments to mirror the market as a whole or an index like the S&P 500. Investments like mutual funds are considered “active” investments, meaning a (very well-paid) fund manager and her staff will make daily decisions about buying some stocks and dropping others for the fund. B-school labor doesn’t come cheap, and the fund manager and staff salaries are passed on to you in the form of management expense ratios (MERs), a percentage of the entire value of the fund that’s deducted annually regardless of the performance of the fund. The average MER on American mutual funds is about 1%, in Canada it’s closer to 2%, and the UK’s right in between those two. These may not seem like huge numbers, but check out the math of one Toronto-based investment advisor who demonstrated that a small-seeming fee of 2% could actually decrease investment gains by half over the course of 25 years.

These fees would certainly be justifiable if there was evidence that actively-managed funds outperformed passively managed ones enough to justify those fees, but in fact tons of studies show that over the long term, the vast majority of professionals paid to pick stocks fail to outperform the market as a whole.

Can you make a lot of money in stocks?

Yes, you can, if you invest well. You can also lose a lot. This doesn’t mean you should invest with hopes to get rich in a short period of time. It rather means that happens to be a set of practices which, if followed, and if history is any judge, will increase the probability that your portfolio will increase slowly over time.

Examples of succesful stock investing

Examples of unsuccessful stock investing

All that restrained waiting sounds well and good, you might think, but hey, what about Amazon? It’s true, if you had access to a time-traveling Delorean and invested in Amazon or Apple or Netflix when they first IPO’ed, you would have made a lot of money. But you can also lose a heck of a lot of money in stocks, as the famous debacles like the Pets.com’s IPO show. Pets.com, which seemed like a great idea to a lot of smart people, went as high as 14 dollars a share only to fall to 22 cents before disappearing altogether.

Do you feel like you have the magical skills to tell the difference between tomorrow’s Amazon and Pets.com? If you do, you may want to follow the so-called 5% rule of investing. Many experts say that in orderly to be properly diversified, no one stock or sector should represent more than 5% of your total portfolio.

What makes stocks go up and down in value?

There are a variety of technical reasons why stocks go up and down, and on the television, you’ll hear lots of news about stocks rising and falling based on factors like earnings per share. You might want to take a deeper dive on those issues. But to take a somewhat more basic view, stocks rise and fall based on very simple issues of supply and demand. If a lot of people decide at once that a stock is undervalued, they’ll all try to buy it at the current price. Because there won’t be enough stock to satisfy all those interested buyers, demand will exceed supply, which will naturally drive the price up. Conversely, if lots of people decide they want to sell their stock at once, this will create a supply that exceeds the demand, and the price will fall until the price reaches a state of equilibrium, a condition in which supply and demand are the same.

One thing that will provide some valuable insight into stock pricing is the concept of “equity risk premium.” Stocks, as you probably know by now, are a riskier investment than government bonds. In exchange for the risk of losing some, or even all of their investment, investors expect to be paid a premium, that is, more than they would make if they parked their money in a very low risk investment like those bonds. This concept keeps stocks viable; if a stock wasn’t expected to outperform the risk-free rate, investors would just stick with the safe money and a stock price would crater. So one of the most important responsibilities of a company CEO is to do everything she can to make sure that investors get bigger rewards in exchange for their risk than they would parking their money in something safe like bonds. A competent CEO knows all about the equity risk premium and does everything she can to make sure the stock price at the very least outpaces the rate of return of a government bond. A lot succeed spectacularly, and quite a few fail too.

Eager to locate someone who finds nothing more exciting than talking stock market investing? Give us a ring. Wealthsimple is one of the only automated investing services to offer all of its clients unlimited human support. Every Wealthsimple client gets state of the art technology, low fees and the kind of personalized, friendly service you might have not thought imaginable from a low-priced investment service.

Can You Earn Money in Stocks?

The New York Stock Exchange (NYSE) was created on May 17, 1792, when 24 stockbrokers and merchants signed an agreement under a buttonwood tree at 68 Wall Street. Countless fortunes have been made and lost since that time, while shareholders fueled an industrial age that’s now spawned a landscape of too-big-to-fail corporations. Insiders and executives have profited handsomely during this mega-boom, but how have smaller shareholders fared, buffeted by the twin engines of greed and fear?

Key Takeaways

The Basics of Stocks

Stocks make up an important part of any investor’s portfolio. These are shares in a publicly-traded company that are listed on a stock exchange. The percentage of stocks you hold, what kind of industries in which you invest, and how long you hold them depend on your age, risk tolerance, and your overall investment goals.

Discount brokers, advisors, and other financial professionals can pull up statistics showing stocks have generated outstanding returns for decades. However, holding the wrong stocks can just as easily destroy fortunes and deny shareholders more lucrative profit-making opportunities.

In addition, those bullet points won’t stop the pain in your gut during the next bear market, when the Dow Jones Industrial Average (DJIA) could drop more than 50%, as it did between October 2007 and March 2009.

Retirement accounts like 401(k)s and others suffered massive losses during that period, with account holders ages 56 to 65 taking the greatest hit because those approaching retirement typically maintain the highest equity exposure.

The Employee Benefit Research Institute

The Employee Benefit Research Institute (EBRI) studied the crash in 2009, estimating it could take up to 5 years for 401(k) accounts to recover those losses at an average 5% annual return. That’s little solace when years of accumulated wealth and home equity are lost just before retirement, exposing shareholders to the worst possible time in their lives.

That troubling period highlights the impact of temperament and demographics on stock performance, with greed inducing market participants to buy equities at unsustainably high prices while fear tricks them into selling at huge discounts. This emotional pendulum also fosters profit-robbing mismatches between temperament and ownership style, exemplified by an uninformed crowd speculating and playing the trading game because it looks like the easiest path to fabulous returns.

Making Money in Stocks: The Buy-and-Hold Strategy

The buy-and-hold investment strategy became popular in the 1990s, underpinned by the «four horsemen of tech»—a quartet of huge technology stocks (Microsoft (MSFT), Intel Corp. (INTC), Cisco Systems (CSCO), and the now-private Dell Computer) fueling the rise in the internet sector and driving the Nasdaq to unprecedented heights. They seemed like such sure things that financial advisors recommended them to clients as companies to buy and hold for life. Unfortunately, many folks following their advice bought late in the bull market cycle, so when the dotcom bubble burst, the prices of these inflated equities collapsed too.

Despite such setbacks, the buy-and-hold strategy bears fruit with less volatile stocks, rewarding investors with impressive annual returns. It remains recommended for individual investors who have the time to let their portfolios grow, as historically the stock market has appreciated over the long term.

The Raymond James and Associates Study

In 2011, Raymond James and Associates published a study of the long-term performance of different assets, examining the 84-year period between 1926 and 2010. During that time, small-cap stocks booked an average 12.1% annual return, while large-cap stocks lagged modestly with a 9.9% return. Both asset classes outperformed government bonds, Treasury bills (T-bills), and inflation, offering highly advantageous investments for a lifetime of wealth building.

Equities had a particularly strong performance between 1980 and 2010, posting 11.4% annual returns. But the real estate investment trust (REIT) equity sub-class beat the broader category, posting 12.3% returns, with the baby boomer-fueled real estate bubble contributing to that group’s impressive performance. This temporal leadership highlights the need for careful stock picking within a buy-and-hold matrix, either through well-honed skills or a trusted third-party advisor.

Large stocks underperformed between 2001 and 2010, posting a meager 1.4% return while small stocks retained their lead with a 9.6% return. The results reinforce the urgency of internal asset class diversification, requiring a mix of capitalization and sector exposure. Government bonds also surged during this period, but the massive flight to safety during the 2008 economic collapse likely skewed those numbers.

The James study identifies other common errors with equity portfolio diversification, noting that risk rises geometrically when one fails to spread exposure across capitalization levels, growth versus value polarity, and major benchmarks, including the Standard & Poor’s (S&P) 500 Index.

In addition, results achieve optimal balance through cross-asset diversification that features a mix between stocks and bonds. That advantage intensifies during equity bear markets, easing downside risk.

The Importance of Risk and Returns

Making money in the stock market is easier than keeping it, with predatory algorithms and other inside forces generating volatility and reversals that capitalize on the crowd’s herd-like behavior. This polarity highlights the critical issue of annual returns because it makes no sense to buy stocks if they generate smaller profits than real estate or a money market account.

While history tells us that equities can post stronger returns than other securities, long-term profitability requires risk management and rigid discipline to avoid pitfalls and periodic outliers.

Modern Portfolio Theory

The modern portfolio theory provides a critical template for risk perception and wealth management. whether you’re just starting out as an investor or have accumulated substantial capital. Diversification provides the foundation for this classic market approach, warning long-term players that owning and relying on a single asset class carries a much higher risk than a basket stuffed with stocks, bonds, commodities, real estate, and other security types.

We must also recognize that risk comes in two distinct flavors: systematic and unsystematic. The systematic risk from wars, recessions, and black swan events—events that are unpredictable with potentially severe outcomes—generates a high correlation between diverse asset types, undermining diversification’s positive impact.

Unsystematic Risk

Unsystematic risk addresses the inherent danger when individual companies fail to meet Wall Street expectations or get caught up in a paradigm-shifting event, like the food poisoning outbreak that dropped Chipotle Mexican Grill’s stock more than 500 points between 2015 and 2017.

Many individuals and advisors deal with unsystematic risk by owning exchange-traded funds (ETFs) or mutual funds instead of individual stocks. Index investing offers a popular variation on this theme, limiting exposure to S&P 500, Russell 2000, Nasdaq 100, and other major benchmarks.

Index funds whose portfolios mimic the components of a particular index can be either ETFs or mutual funds. Both have low expense ratios, compared to regular, actively managed funds, but of the two, ETFs tend to charge lower fees.

Both approaches lower, but don’t eliminate unsystematic risk because seemingly unrelated catalysts can demonstrate a high correlation to market capitalization or sector, triggering shock waves that impact thousands of equities simultaneously. Cross-market and asset class arbitrage can amplify and distort this correlation through lightning-fast algorithms, generating all sorts of illogical price behavior.

Common Mistakes Investor Make

The 2011 Raymond James study noted that individual investors underperformed the S&P 500 badly between 1988 and 2008, with the index booking an 8.4% annual return compared to a limp 1.9% return for individuals.

How to explain this underperformance? Investor missteps bear some of the blame. Some common mistakes include:

Lack of diversification: Top results highlight the need for a well-constructed portfolio or a skilled investment advisor who spreads risk across diverse asset types and equity sub-classes. A superior stock or fund picker can overcome the natural advantages of asset allocation, but sustained performance requires considerable time and effort for research, signal generation, and aggressive position management. Even skilled market players find it difficult to retain that intensity level over the course of years or decades, making allocation a wiser choice in most cases.

However, asset allocation makes less sense in small trading and retirement accounts that need to build considerable equity before engaging in true wealth management. Small and strategic equity exposure may generate superior returns in those circumstances while account-building through paycheck deductions and employer matching contributes to the bulk of capital.

Market timing: Concentrating on equities alone poses considerable risks because individuals may get impatient and overplay their hands by making the second most detrimental mistake such as trying to time the market.

Professional market timers spend decades perfecting their craft, watching the ticker tape for thousands of hours, identifying repeating patterns of behavior that translate into a profitable entry and exit strategies. Timers understand the contrary nature of a cyclical market and how to capitalize on the crowd’s greed or fear-driven behavior. This is a radical departure from the behaviors of casual investors, who may not fully understand how to navigate the cyclical nature of the market. Consequently, their attempts to time the market may betray long-term returns, which could ultimately shake an investor’s confidence.

Emotional bias: Investors often become emotionally attached to the companies they invest in, which can cause them to take larger than necessary positions, and blind them to negative signals. And while many are dazzled by the investment returns on Apple, Amazon, and other stellar stock stories, in reality, paradigm-shifters like these are few and far between.

What’s required is a journeyman’s approach to stock ownership, rather than a gunslinger strategy. This can be difficult because the internet tends to hype the next big thing, which can whip investors into a frenzy over undeserving stocks.

Know the Difference: Trading vs. Investing

Employer-based retirement plans, such as 401(k) programs, promote long-term buy and hold models, where asset allocation rebalancing typically occurs only once per year. This is beneficial because it discourages foolish impulsivity. As years go by, portfolios grow, and new jobs present new opportunities, investors cultivate more money with which to launch self-directed brokerage accounts, access self-directed rollover individual retirement accounts (IRAs), or place investment dollars with trusted advisors, who can actively manage their assets.

On the other hand, increased investment capital may lure some investors into the exciting world of short-term speculative trading, seduced by tales of day trading rock stars richly profiting from technical price movements. But in reality, these renegade trading methods are responsible for more total losses than they are for generating windfalls.

As with market timing, profitable day trading requires a full-time commitment that’s nearly impossible when one is employed outside the financial services industry. Those within the industry view their craft with as much reverence as a surgeon views surgery, keeping track of every dollar and how it’s reacting to market forces. After enduring their fair shares of losses, they appreciate the substantial risks involved, and they know how to shrewdly sidestep predatory algorithms while dismissing folly tips from unreliable market insiders.

Studies That Analyze Day Trading

In 2000, The Journal of Finance published a University of California, Davis study that addressed common myths ascribed to active stock trading. After polling more than 60,000 households, the authors learned that such active trading generated an average annual return of 11.4%, from 1991 and 1996—significantly less than the 17.9% returns for the major benchmarks during the same period. Their findings also showed an inverse relationship between returns and the frequency with which stocks were bought or sold.

The study also discovered that a penchant for small high-beta stocks, coupled with over-confidence, typically led to underperformance, and higher trading levels. This supports the notion that gunslinger investors errantly believe that their short-term bets will pan out. This approach runs counter to the journeyman’s investment method of studying long-term underlying market trends, to make more informed and measured investment decisions.

in a 2015 study, authors Xiaohui Gao and Tse-Chun Lin offered interesting evidence that individual investors view trading and gambling as similar pastimes, noting how the volume on the Taiwan Stock Exchange inversely correlated with the size of that nation’s lottery jackpot. These findings line up with the fact that traders speculate on short-term trades in order to capture an adrenaline rush, over the prospect of winning big.

Interestingly, losing bets produce a similar sense of excitement, which makes this a potentially self-destructive practice, and explains why these investors often double down on bad bets. Unfortunately, their hopes of winning back their fortunes seldom pan out.

Finances, Lifestyle, and Psychology

Profitable stock ownership requires narrow alignment with an individual’s personal finances. Those entering the professional workforce for the first time may initially have limited asset allocation options for their 401(k) plans. Such individuals are typically restricted to parking their investment dollars in a few reliable blue-chip companies and fixed income investments that offer steady long-term growth potential.

On the other hand, while individuals nearing retirement may have accumulated substation wealth, they may not have enough time to (slowly, but surely) build returns. Trusted advisors can help such individuals manage their assets in a more hands-on, aggressive manner. Still, other individuals prefer to grow their burgeoning nest eggs through self-directed investment accounts.

Self-directed investment retirement accounts (IRAs) have advantages—like being able to invest in certain kinds of assets (precious metals, real estate, cryptocurrency) that are off-limits to regular IRAs. However, many traditional brokerages, banks, and financial services firms do not handle self-directed IRAs. You will need to establish the account with a separate custodian, often one that specializes in the type of exotic asset you’re investing in.

Younger investors may hemorrhage capital by recklessly experimenting with too many different investment techniques while mastering none of them. Older investors who opt for the self-directed route also run the risk of errors. Therefore, experienced investment professionals stand the best chances of growing portfolios.

It’s imperative that personal health and discipline issues be fully addressed before engaging in a proactive investment style because markets tend to mimic real life. Unhealthy, out-of-shape individuals who carry low self-esteem may engage in short-term speculative trading because they subconsciously believe they’re unworthy of financial success. Knowingly partaking in risky trading behavior that has a high chance of ending poorly may be an expression of self-sabotage.

The Ostrich Effect

A 2006 study published in the Journal of Business coined the term the «ostrich effect,» to describe how investors engage in selective attention when it comes to their stock and market exposure, viewing portfolios more frequently in rising markets and less frequently (or “putting their heads in the sand”) in falling markets.

The study further elucidated how these behaviors affect the trading volume and market liquidity. Volumes tend to increase in rising markets and a decrease in falling markets, adding to the observed tendency for participants to chase uptrends while turning a blind eye to downtrends. Over-coincidence could offer the driving force once again, with the participant adding new exposure because the rising market confirms a pre-existing positive bias.

The loss of market liquidity during downturns is consistent with the study’s observations, indicating that “investors temporarily ignore the market in downturns—so as to avoid coming to terms mentally with painful losses.” This self-defeating behavior is also prevalent in routine risk management undertakings, explaining why investors often sell their winners too early while letting their losers run—the exact opposite archetype for long-term profitability.

Panic-Inducing Situations

Wall Street loves statistics that show the long-term benefits of stock ownership, which is easy to see when pulling up a 100-year Dow Industrial Average chart, especially on a logarithmic scale that dampens the visual impact of four major downturns.

The 84 years examined by the Raymond James study witnessed no less than three market crashes, generating more realistic metrics than most cherry-picked industry data.

Ominously, three of those brutal bear markets have occurred in the past 31 years, well within the investment horizon of today’s baby boomers. In-between those stomach-wrenching collapses, stock markets have gyrated through dozen of mini-crashes, downdrafts, meltdowns, and other so-called outliers that have tested the willpower of stock owners.

It’s easy to downplay those furious declines, which seem to confirm the wisdom of buy and hold investing, but psychological shortcomings outlined above invariably come into play when markets turn lower. Legions of otherwise rational shareholders dump long-term positions like hot potatoes when these sell-offs pick up speed, seeking to end the daily pain of watching their life savings go down the toilet.

Ironically, the downturn ends magically when enough of these folks sell, offering bottom fishing opportunities for those incurring the smallest losses or winners who placed short sale bets to take advantage of lower prices.

Black Swans and Outliers

Nassim Taleb popularized the concept of a black swan event, an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences, in his 2010 book The Black Swan: The Impact of the Highly Improbable. He describes three attributes for a black swan:

Given the third attitude, it’s easy to understand why Wall Street never discusses a black swan’s negative effect on stock portfolios.

The term «black swan,» meaning something rare or unusual, originated from the once widespread belief that all swans were white—simply because no one had ever seen one of a different color. In 1697, the Dutch explorer Willem de Vlamingh spied black swans in Australia, exploding that assumption. After that, the term «black swan» morphed to suggest an unpredictable or impossible thing that actually is just waiting to occur or be proven to exist.

Shareholders need to plan for black swan events in normal market conditions, rehearsing the steps they’ll take when the real thing comes along. The process is similar to a fire drill, paying close attention to the location of exit doors and other means of escape if required. They also need to rationally gauge their pain tolerance because it makes no sense to develop an action plan if it’s abandoned the next time the market enters a nosedive.

Of course, Wall Street wants investors to sit on their hands during these troubling periods, but no one but the shareholder can make that life-impacting decision.

How Do Beginners Make Money in the Stock Market?

Beginners can make money in the stock market by:

Starting early—thanks to the miracle of compounding (when interest is earned on already-accrued interest and earnings), investments grow exponentially. Even a small amount can grow substantially if left untouched.

Thinking long-term—the stock market has its ups and downs, but historically, it’s appreciated—that is, increased in value—over the long haul. Having a far-off time horizon smooths out the volatility of short-term market dips and drops.

Being regular—invest in a constant, disciplined manner. Take advantage of your employer’s 401(k), if one exists, which automatically will deduct a percentage of your paycheck to invest in funds you choose. Or adopt a strategy like dollar-cost averaging, investing equal amounts, spaced out over regular intervals, in certain assets, regardless of their price.

Relying on the pros—don’t try to pick stocks yourself. There are financial professionals whose job is to «manage money,» and when you invest in a mutual fund, ETF, or other managed fund, you’re tapping into their expertise, experience, and analysis. Leave the driving, er, investing, to them, in other words. Investing in funds also has the advantage of diversification—their portfolios own dozens, even hundreds of individual stocks—which cuts risk.

Can You Make a Lot of Money in Stocks?

Yes, if your goals are realistic. Although you hear of making a killing with a stock that doubles, triples, or quadruples in price, such occurrences are rare, and/or usually reserved for day traders or institutional investors who take a company public.

For individual investors, it’s more realistic to base expectations on how the stock market has performed on average over a certain time period. For example, the S&P 500 Index (SPX), widely considered a benchmark for the U.S. stock market itself, has returned nearly 15% in the last five years, 12% in the last 10 years. Since 1990, its value (as of 2021) has increased eleven-fold, from 330 to 4127.

What Are Three Ways to Make Money in the Stock Market?

Three ways to make money in the stock market are:

Sell stock shares at a profit—that is, for a higher price than you paid for them. This is the classic strategy, «buy low, sell high.»

Short-selling—This strategy is a reverse of the classic one above; it might be dubbed «sell high, buy low.» When you sell short, you borrow shares of stock (usually from a broker), sell them on the open market, and then buy them back later—if and when the price drops. Returning the shares to the lender, you pocket the profit. Short-selling is a bet that a stock will decline in value.

Collecting dividends—Many stocks pay dividends, a distribution of the company’s profits per share. Typically issued each quarter, they’re an extra reward for shareholders, usually paid in cash but sometimes in additional shares of stock.

How Do You Take Profits From Stocks?

The ultimate aim of every investor is to make a profit from their stocks, of course. But knowing when to actually cash out and take that profit, locking in gains, is a key question, and there’s no one right answer. Much depends on an investor’s risk tolerance and time horizon—that is, how long they can afford to wait for the stock to earn, vis-a-vis how much profit they want to earn.

Don’t be greedy. Some financial pros recommend taking a profit after a stock has appreciated around 20% to 25% in price—even if it still seems to be rising. «The secret is to hop off the elevator on one of the floors on the way up and not ride it back down again,» as Investor’s Business Daily founder William O’Neil put it.

Other advisors use a more complex rule of thumb, involving gradual profit-taking. Jeffrey Hirsch, chief market strategist at Probabilities Fund Management and editor-in-chief of The Stock Market Almanac, for example, has an «up 40%, sell 20%» strategy: When a stock goes up by 40%, sell 20% of the position; when it goes up another 40%, sell another 20%, and so on.

The Bottom Line

Yes, you can earn money from stocks and be awarded a lifetime of prosperity, but potential investors walk a gauntlet of economic, structural, and psychological obstacles. The most reliable path to long-term profitability will start small by picking the right stockbroker and beginning with a narrow focus on wealth building, expanding into new opportunities as capital grows.

Buy-and-hold investing offers the most durable path for the majority of market participants. The minority who master special skills can build superior returns through diverse strategies that include short-term speculation and short selling.

How to Invest in Stocks: A Beginner’s Guide for Getting Started

Stock investing, when done well, is among the most effective ways to build long-term wealth.

Here’s a step-by-step guide to investing money in the stock market to help ensure you’re doing it the right way.

5 Steps to Start Investing

1. Determine your investing approach

The first thing to consider is how to start investing in stocks. Some investors choose to buy individual stocks, while others take a less active approach.

Try this. Which of the following statements best describes you?

The good news is that regardless of which of these statements you agree with, you’re still a great candidate to become a stock market investor. The only thing that will change is the «how.»

The different ways to invest in the stock market

Individual stocks

Index funds

In addition to buying individual stocks, you can choose to invest in index funds, which track a stock index like the S&P 500. When it comes to actively vs. passively managed funds, we generally prefer the latter (although there are certainly exceptions). Index funds typically have significantly lower costs and are virtually guaranteed to match the long-term performance of their underlying indexes. Over time, the S&P 500 has produced total returns of about 10% annualized, and performance like this can build substantial wealth over time.

Robo-advisors

Finally, another option that has exploded in popularity in recent years is the robo-advisor. A robo-advisor is a brokerage that essentially invests your money on your behalf in a portfolio of index funds that is appropriate for your age, risk tolerance, and investing goals. Not only can a robo-advisor select your investments, but many will optimize your tax efficiency and make changes over time automatically.

2. Decide how much you will invest in stocks

First, let’s talk about the money you shouldn’t invest in stocks. The stock market is no place for money that you might need within the next five years, at a minimum.

Asset allocation

Let’s start with your age. The general idea is that as you get older, stocks gradually become a less desirable place to keep your money. If you’re young, you have decades ahead of you to ride out any ups and downs in the market, but this isn’t the case if you’re retired and reliant on your investment income.

Here’s a quick rule of thumb that can help you establish a ballpark asset allocation. Take your age and subtract it from 110. This is the approximate percentage of your investable money that should be in stocks (this includes mutual funds and ETFs that are stock based). The remainder should be in fixed-income investments like bonds or high-yield CDs. You can then adjust this ratio up or down depending on your particular risk tolerance.

For example, let’s say that you are 40 years old. This rule suggests that 70% of your investable money should be in stocks, with the other 30% in fixed income. If you’re more of a risk taker or are planning to work past a typical retirement age, you may want to shift this ratio in favor of stocks. On the other hand, if you don’t like big fluctuations in your portfolio, you might want to modify it in the other direction.

3. Open an investment account

All of the advice about investing in stocks for beginners doesn’t do you much good if you don’t have any way to actually buy stocks. To do this, you’ll need a specialized type of account called a brokerage account.

These accounts are offered by companies such as TD Ameritrade, E*Trade, Charles Schwab, and many others. And opening a brokerage account is typically a quick and painless process that takes only minutes. You can easily fund your brokerage account via EFT transfer, by mailing a check, or by wiring money.

Opening a brokerage account is generally easy, but you should consider a few things before choosing a particular broker:

Type of account

First, determine the type of brokerage account you need. For most people who are just trying to learn stock market investing, this means choosing between a standard brokerage account and an individual retirement account (IRA).

Both account types will allow you to buy stocks, mutual funds, and ETFs. The main considerations here are why you’re investing in stocks and how easily you want to be able to access your money.

If you want easy access to your money, are just investing for a rainy day, or want to invest more than the annual IRA contribution limit, you’ll probably want a standard brokerage account.

Compare costs and features

The majority of online stock brokers have eliminated trading commissions, so most (but not all) are on a level playing field as far as costs are concerned.

However, there are several other big differences. For example, some brokers offer customers a variety of educational tools, access to investment research, and other features that are especially useful for newer investors. Others offer the ability to trade on foreign stock exchanges. And some have physical branch networks, which can be nice if you want face-to-face investment guidance.

There’s also the user-friendliness and functionality of the broker’s trading platform. I’ve used quite a few of them and can tell you firsthand that some are far more «clunky» than others. Many will let you try a demo version before committing any money, and if that’s the case, I highly recommend it.

How to Make Money in Stocks

The best way to build wealth isn’t from buying and selling

Ngampol Thongsai/EyeEm / Getty Images

Chip Stapleton is a Series 7 and Series 66 license holder, passed the CFA Level 1 exam, and is a CFA Level 2 candidate. He, and holds a life, accident, and health insurance license in Indiana. He has eights years’ experience in finance, from financial planning and wealth management to corporate finance and FP&A.

Investing is one of the best ways to build wealth over your lifetime, and it requires less effort than you might think.

Making money from stocks doesn’t mean trading often, being glued to a computer screen, or spending your days obsessing about stock prices. The real money in investing is generally made not from buying and selling but from three things:

How To Make Money in the Stock Market

The best way to make money in the stock market isn’t with frequent buying and selling, but with a strategy known as «buying and holding.» This strategy was popularized by the father of value investing, Benjamin Graham, and is used by high-profile, successful investors like Warren Buffett.

As an investor in common stocks, you need to focus on total return and make a decision to invest for the long term. This means that you:

If you have chosen strong, well-run companies, the value of your stock will increase over time. As an example, you can view four popular stocks below to see how their prices increased over five years.

Successful Buying and Holding

High-profile investors like Warren Buffett and Charlie Munger have held onto stocks and businesses for decades to make the bulk of their money. Other everyday investors have followed in their footsteps, taking small amounts of money and investing it long term to amass tremendous wealth.

The stock market is unpredictable, and constantly buying and selling in order to «beat» the market rarely works in the long term. Instead, you are more likely to be a successful investor if you choose valuable stocks and hold onto them for years.

How Stocks Work

Before you can make money from the stock market, it’s important to understand how owning stocks works. This will allow you to make smart decisions about where to invest your money.

When you buy a share of stock, you are purchasing ownership in a company. Consider the following example:

If the management team can increase sales by five times in the next few years, your share of profits could also be five times higher, making Harrison Fudge Company a valuable long-term investment.

When you own stock in a company, however, you don’t immediately see the per-share profits that belong to you. Instead, management and the board of directors have options for what to do with those profits, and their choice will impact your holdings.

What Strategy Is Best for You?

Which strategy is best for you as an owner depends entirely on the rate of return management can earn by reinvesting your money. Sometimes, paying out cash dividends is a mistake because those funds could be reinvested into the company and contribute to a higher growth rate, which would increase the value of your stock.

Other times, the company is an old, established brand that can continue to grow without significant reinvestment in expansion. In these cases, the company is more likely to use its profit to pay dividends to shareholders.

Valuable investments can choose any of these paths. Berkshire Hathaway, for example, pays out no cash dividends, while U.S. Bancorp has resolved to return more than 80% of capital to shareholders in the form of dividends and stock buybacks each year. Despite these differences, they both have the potential to be attractive holdings at the right price.   

The best way to determine whether a stock is a good investment is to look at the company’s asset placement and understand how it manages its money.

Building Wealth by Investing in Stock

When you understand more about how stocks work, it’s easier to understand that your wealth is built primarily from:

For Example:

Using a DRIP (dividend reinvestment plan) allows you to reinvest your dividends to purchase more stock in the company.   This allows you to purchase fractional shares and steadily increase your stock holdings.

Occasionally, during market bubbles, you may have the opportunity to make a profit by selling your shares for more than the company is worth. And if you need cash for an unexpected emergency, having stock available to sell can provide a valuable financial cushion.

In the long run, however, your returns depend on the underlying profits generated by the operations of the businesses in which you invest. Choosing your stock wisely and holding onto it for the long term is the most reliable way to generate wealth.

Frequently Asked Questions (FAQs)

How do I start buying stocks?

You can buy stock through full-service stockbrokers, online stockbrokers, or directly from the company. You’ll need to set up an account through one of these channels and connect your bank account. Then you can begin researching and purchasing stocks.

How much money do you need to start buying stocks?

How To Make Money In Stocks: 2 Key Rules To Get Rich Fast (+ tips)

If you’re looking into investing in stocks right now, you’re probably wondering how you can best invest in stocks during a pandemic.

Here’s what might surprise you: The stocks to buy during coronavirus aren’t really that different than the stocks you should buy normally.

But let’s go back to the basics for a second. Investing in stocks is one of the most important financial skills you need to master. On average, stocks have given an annualized return of around 10%. At that rate, your money doubles every 7.2 years.

I’m going to level with you. You can’t get rich off just your salary. Savings and bonds won’t do it either, the return isn’t high enough to make an impact during your lifetime. Stocks are the key.

No matter your income, you will get rich off stocks as long as you start investing early, keep investing, and never sell.

Anyone can do this. You don’t need to be a financial wiz, have insider access, or a ton of time. I spend a few hours per YEAR managing my portfolio. Time and consistent contributions will make you a millionaire.

That’s why I have compiled a list of easy things you can start doing from today to make money in stocks. Let’s get right into it.

How to Make Money in Stocks at a Glance:

2 rules for making money in stocks:

The quicker you realize that the stock market is not sexy, the faster you will start making money from it. For 99.9% of people, investing in stocks is nothing like what you saw in The Wolf of Wall Street. It’s also not listening to the so-called “financial experts” on news channels and buying their hottest stocks of the season.

All of that is noise. It won’t help you make money in stocks. Successful stock market investing is all about being patient and staying in the market for many years.

Which brings me to…

Rule #1: Stay invested in the stock market

It’s very easy to panic and sell stocks whenever there’s a big drop in the stock market. However, selling your stocks at the slightest fall or when they are down could be the worst financial decision you can make.

When the markets fall, everyone is talking about the next recession or how things are only going to get worse. I get it. Downtrends are scary. But remember that they appear worse than they actually are because of how much they are discussed and analyzed.

When you are panicking, first of all, take a deep breath.

Since 1900, we’ve seen some real disasters there have been many reasons for the market to fall and not rise:

Through all this, markets have continued to grow at about 10% per year.

Here’s another fascinating stat that I love. In the months following a 10% drop since 1900, this is how much the markets have risen in the immediate future on an average:

What does this tell you?

The stock market has ALWAYS gone up every time it has fallen. So, don’t panic when it goes down. Trust how stock prices have always behaved. In fact, when they fall, try to buy more stocks.

Rule #2: Stop timing the market

My oh my, I have heard about people trying to time the stock market so many times.

Everyone is trying to buy low and sell high. Even Financial advisors are always trying to time the market.

Being able to consistently identify highs and lows is a very difficult skill. Even the people who have spent all their lives trying to master it are not successful at it. It’s impossible to do consistently.

Guess what the most likely outcome is when the stock market hits a new high? More highs! By waiting, you miss out on more gains.

Same thing happens when times are bad. The biggest gains come after the biggest drops. If you try to wait for the market to be “all-clear,” you’ll miss out on them. And you won’t get anywhere close to that 10% annual return.

Here’s something that very few people know about the stock market.

Missing just the 10 best days cuts your returns by more than half. If you missed the top 20, you are just about breaking even (in fact, you are losing money because of inflation).

Trying to time the market can be DEVASTATING. Ignore the news and invest every month like clockwork. That’s how you make the most money.

The best way to invest in stocks

They are the best way to make money in stocks. Index funds put their money in indexes like the S&P 500 or the Russel 1000. Index funds are passive, their fund managers don’t keep buying and selling stocks to “beat the market”. In fact, their objective is to be the market.

They’re also a lot easier to run, so the fees are lower. The taxes are lower too since the fund managers aren’t buying and selling all the time.

Index funds really are a free lunch:

You can also diversify easily through index funds. By nature, they help in diversification, but you can go a step further. You can pick a few index funds across US stocks, international stocks, and bonds. A lazy portfolio like this gives you lots of upside and low amounts of risk that’s super easy to manage.

I recommend making at least 90% of your portfolio through index funds.

How to pick individual stocks (if you must)

I understand you will have the itch to buy individual stocks.

But I am not going to sugarcoat it. Buying stocks is brutally hard.

The odds of successfully picking individual stocks are very low.

From 1926 to 2015, there have been 25,782 distinct stocks.

The odds of success by buying individual stocks are very slim. Just 4%.

That’s why I recommend using only the remaining 10% of your investment capital to buy individual stocks.

I pick a few stocks myself but I keep it well below 10%. I get to scratch the stock-picking itch, eat plenty of humble pie, and then get back to my day.

Have fun with 10% of your portfolio, just don’t go beyond that. Keep the other 90% really boring. You’ll make a lot more money.

Advanced Tip: If you’re really smart, instead of investing in individual stocks that have a very low chance of being successful, you could use that remaining 10% to invest in yourself. You might see even greater returns when you invest in your career or a business. Plus when you invest in yourself, your gains aren’t capped at 10-15%. Instead, you could earn 1,000% or more.

Automate your investments

I’m a huge fan of automating investments. Go into your investment accounts and set a specific amount to get transferred automatically every month

Automating achieves three purposes.

First, you are not trying to time the market. Investing each month allows you to average out the gains and losses. It also makes for smoother returns. When you invest each month, if the market is high, your portfolio still grows. If the market is low, you are buying stocks at a comparatively lower price which will eventually go up.

Second, you don’t forget to actually invest. By setting up automatic investments, you are truly embracing the “set it and forget it” strategy. You’re not relying on yourself to invest. We all forget to do things. With investing, forgetting to invest will rob you of more returns than any recession will. Don’t rely on willpower or your memory, get it automated so you never have to worry about it again.

Third, you can spend freely on the rest. By setting up an automatic transfer to trigger right after you get paid, it never feels like you had the money in the first place. Set up transfers for your investments and savings, set aside enough money for major bills like rent or a mortgage, then spend the rest freely until next month. You’ve done the hard work of taking care of your future by setting up the automatic investment, now go enjoy yourself by living your rich life. Automatic investments allow you to enjoy the present while securing your future. You can have it all.

The first step in making money through stocks

Armed with this new knowledge, you are in a great position to make money in stocks.

The first step is to set up a brokerage account to buy stocks or index funds. We recommend Vanguard, TD Ameritrade, or Fidelity. All are great options for opening your first account.