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This piece has been expert reviewed and fact checked by Forbes Advisor Australia Board Member, Shani Jayamanne, award-winning senior investment specialist at Morningstar, who is also the co-host of Morningstar Australia’s Investing Compass podcast.
Ask any financial expert, and you’ll hear stocks are one of the keys to building long-term wealth. But the tricky thing with stocks is that while over years they can grow in value exponentially, their day-to-day movement is impossible to predict with total accuracy. The ups and downs of the ASX of late is a case in point.
Which begs the question: How can you make money in stocks?
Actually, it isn’t hard, so long as you adhere to some proven practices―and practice patience.
Related: Australian Share Market News
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1. Buy and Hold
There’s a common saying among long-term investors: “Time in the market beats timing the market.”
What does that mean? In short, one common way to make money in stocks is by adopting a buy-and-hold strategy, where you hold stocks or other securities for a long time instead of engaging in frequent buying and selling (a.k.a. trading).
That’s important because investors who consistently trade in and out of the market on a daily, weekly or monthly basis tend to miss out on opportunities for strong annual returns and lose money on transaction costs.
Consider this: The S&P/ASX 200 Index returned an average total return of 9.3% each year over 10 years, according to the S&P Dow Jones Indices, 2021. But if you traded in and out of the market, you jeopardised your chances of seeing those returns, as being out of the market on its best days translates to vastly lower returns.
While it might seem like the easy solution is simply to always make sure you’re invested on those days, it’s impossible to predict when they will be. Sometimes days of strong performance follow days of large dips, and sometimes they won’t. There’s no guarantee.
That means you have to stay invested for the long haul to make sure you capture the stock market at its best. Adopting a buy and hold strategy can help you achieve this goal. (It will also help you come tax time by qualifying you for lower capital gains taxes.)
2. Opt for Funds Over Individual Stocks
Seasoned investors know that a time-tested investing practice called diversification is key to reducing risk and potentially boosting returns over time. Think of it as the investing equivalent of not putting all of your eggs in one basket.
Although most investors gravitate toward two investment types—individual stocks or stock funds, such as managed funds or exchange-traded funds (ETFs)—experts typically recommend the latter to maximise your diversification.
While you can buy an array of individual stocks to emulate the diversification you find automatically in funds, it can take time, a fair amount of investing savvy and a sizeable cash commitment to do that successfully. An individual share of a single stock, for instance, can cost hundreds of dollars.
Funds, on the other hand, let you buy exposure to hundreds (or thousands) of individual investments with a single unit. While everyone wants to throw all of their money into the next Google (GOOGL) or Amazon (AMZN), the simple fact is that most investors, including the professionals, don’t have a strong track record of predicting which companies will deliver outsize returns.
That’s why experts recommend most people invest in funds that passively track major indexes, like the ASX200. This positions you to benefit from the approximate 10% average annual returns of the stock market as easily (and cheaply) as possible.
3. Reinvest your Dividends
Many businesses pay their shareholders a dividend—a periodic income payment based on their earnings.
While the small amounts you get paid in dividends may seem negligible, especially when you first start investing, they’re responsible for a large portion of the stock market’s historic growth.
For example, in the US from September 1921 through September 2021, the S&P 500 saw average annual returns of 6.7%. When dividends were reinvested, however, that percentage jumped to almost 11%. That’s because each dividend you reinvest buys you more shares, which helps your earnings compound even faster.
That enhanced compounding is why many financial advisors recommend long-term investors reinvest their dividends rather than spending them when they receive the payments. Most brokerage companies give you the option to reinvest your dividend automatically by signing up for a dividend reinvestment program, or DRIP.
The Bottom Line
If you want to make money in stocks, you don’t have to spend your days speculating on which individual companies’ stocks may go up or down in the short term. In fact, even the most successful investors, like Warren Buffett, recommend people invest in low-cost index funds and hold onto them for the years or decades until they need their money.
The tried-and-true key to successful investing, then, is unfortunately a little boring. Simply have patience that diversified investments, like index funds, will pay off over the long term, instead of chasing the latest hot stock.
Note: When investing, it’s possible to lose some, and very occasionally all, of your money. Past performance is no prediction of future performance and this article is not intended as a recommendation of any particular asset class, investment strategy or product.
