Ask any financial expert and you’ll hear that stocks are one of the keys to building long-term wealth. But the tricky thing about stocks is that while they can multiply in value over the years, their day-to-day movements cannot be predicted with complete accuracy.
Which begs the question: how do you make money in stocks?
It’s actually not that hard, as long as you stick to a few proven practices — and practice patience.
1. Buy and hold
Long-term investors have a saying: “Time to enter the market trumps market timing.”
what does that mean? In a nutshell, a common way to make money in stocks is to employ a buy-and-hold strategy, where you hold stocks or other securities for a long period of time instead of buying and selling them frequently (also known as trading).
This is important because investors who are constantly in and out of the market on a daily, weekly or monthly basis tend to miss out on strong annual returns. Do not believe?
Consider this: For the 15 years ending in 2017, the stock market returned 9.9% annually for those who remained fully invested, according to Putnam Investments. But if you go in and out of the market, you jeopardize your chances of seeing those returns.
- For investors who missed the best 10 days of that period, their annual return was only 5%.
- For those who missed their 20 best days, the annual return was only 2%.
- Missing the best 30 days actually results in an average annual loss of -0.4%.
Clearly, getting out of the market on the best of days means significantly lower returns. While the seemingly simple solution is just to always make sure you invest in those days, there’s no way to predict when they’ll show up, and strong days are sometimes followed by big down days.
read more: How to invest in the US market from India
This means that you must maintain your investments over the long term to ensure you are in the best position to capture the stock market. Employing a buy-and-hold strategy can help you achieve this goal. (And, more importantly, it helps you save tax time by making you eligible for lower capital gains taxes.)
2. Choose funds over individual stocks
Seasoned investors know that a proven investment practice called diversification is the key to reducing risk and potentially improving returns over time. Think of it as the investment equivalent of not putting all your eggs in one basket.
While most investors prefer both investment types—individual stocks or equity funds, such as mutual funds or exchange-traded funds (ETFs)—experts generally recommend the latter for maximum diversification.
While you can buy a range of individual stocks to mimic the diversification you automatically find in a fund, doing so successfully can take time, a fair amount of investment acumen, and a substantial cash commitment. For example, a single share of a single stock can cost hundreds of dollars.
Funds, on the other hand, allow you to buy exposure to hundreds (or thousands) of individual investments with a single stock. While everyone wants to put all their money into the next Apple (AAPL) or Tesla (TSLA), the simple fact is that most investors, including the pros, are predicting which companies will deliver outsized returns There is no good record in this regard.
This is why experts recommend that most people invest in funds that passively track major indices, such as NSE Nifty or BSE Sensex. This allows you to benefit from the stock market’s average annual return of around 10% as easily (and cheaply) as possible.
3. Reinvest dividends
Many businesses pay dividends to shareholders — regular payments based on their earnings.
While the small dividends you receive may seem negligible, especially when you’re just starting out, they’re largely responsible for the stock market’s historical growth. Since its inception, the Nifty 50 has returned about 12%, a percentage that jumps to nearly 16% when dividends are reinvested. That’s because every dividend you reinvest buys you more stock, which helps your earnings compound faster.
This enhanced compounding is why many financial advisors recommend that long-term investors reinvest their dividends rather than spend them when they receive payments. Most brokerage firms offer you the option to automatically reinvest your dividends through a registered dividend reinvestment plan or DRIP.
4. Choose the right investment account
While the specific investments you choose are undoubtedly important to your long-term investment success, the account in which you choose to hold them is also critical.
This is because some investment accounts offer you certain tax benefits, such as the National Pension Scheme (NPS). It allows you to avoid paying taxes on any gains or income you hold in your account. This can speed up your retirement fund because you can defer those positive-returning taxes for decades.
The minimum amount required to open an NPS account is INR 500 and each subscriber can have a maximum of one account.
NPS Tier I is a tax-exempt investment, tax-exempt at all stages of investment and return. The amount invested, the interest earned, and the total amount withdrawn at the end of the plan are all tax-free. After the age of 60, you can withdraw up to 60% of your total investment. This 60% investment will be considered tax-free.
Of course, certain circumstances, such as onerous medical bills or dealing with the economic fallout of the Covid-19 pandemic, can give you early access to the money for free. But the general rule of thumb is that once you put money into a tax-advantaged retirement account, you shouldn’t touch it until you reach retirement age.
Meanwhile, plain old taxable investment accounts don’t offer the same tax benefits, but allow you to withdraw money anytime, anywhere for any purpose. This allows you to take advantage of certain strategies, such as tax cut harvesting, which involves you turning losing stocks into winners by selling them at a loss and getting some tax deductions on the gains.
All this is to say, you need to invest in the “right” account to optimize your returns. A taxable account can be a good place to store your investments, which typically lose less tax or the money you need for years or decades to come. Conversely, investments that are likely to lose more tax returns or that you plan to hold for the long term may be better suited for a tax-advantaged account.
Most brokerage firms (but not all) offer both types of investment accounts, so make sure the firm you choose has the type of account you need. If you don’t, or you’re just starting your investing journey, check out Forbes Advisors’ list of the best brokers to find the right option for you.
If you want to make money on stocks, you don’t have to spend all day speculating that individual companies’ stocks might rise or fall in the short term. In fact, even the most successful investors like Warren Buffett advise people to invest in low-cost index funds and hold them for years or decades until they need the money. Well, the surefire key to successful investing is that it’s a pity that it’s a little boring. Just be patient and diversified investments, like index funds, will pay off over the long term, rather than chasing the latest hot stock.