These days, it seems like you can't go a day without hearing about "stocks." Every day there's a news story about how good or bad stocks are doing, or how new investors became millionaires off a single stock. Investing companies continually bombard you to invest your money with them, advertising that the only way to retire is to invest in the stock market. (With them, of course.) You may even have friends and family that talk about their successful stocks.
It seems like everyone is investing in stocks and are making money, which can leave you feeling left out if you aren't. This might have you thinking, "Should I start investing in stocks? Is investing in stocks worth it?"
Investing in stocks can be a great way to build wealth over the long term, but they usually aren't the "get-rich-quick" scheme the media or brokerage firms make them seem. Let's dive more into this so you can decide if investing in stocks is good for you and your goals or not.
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Everyone is at a different place in their financial journey. Some people may have the savings they need for a comfortable retirement while others are living paycheck to paycheck.
The stories you hear are usually about people whose financial situations are completely different from yours. Just because the people in these stories, or even your friends and family members, are investing in stocks, it doesn't mean you should.
So where should you be financially before you can consider investing?
If you live paycheck to paycheck, you should not be investing in stocks. Stocks have high volatility and have a risk of losing value, and you should not be risking the money you need to pay for your necessary expenses.
If you do not have the money to cover a $400 expense like many Americans don't, you should not be investing in stocks. It's recommended that you instead look towards saving what you can, paying down debt, and working towards a future where you do have discretionary income to spend on things like investing.
But what if you don't live paycheck to paycheck? What if you are financially stable and want to put some of your savings to work for you?
Should you invest in stocks then? You should only begin thinking about investing in stocks if you have a usable amount of emergency savings.
Many financial advisors recommend that one of the smartest things you can do is to have an emergency fund or a "rainy day" fund. This emergency fund serves as a way to help you survive financially if something unexpected happens.
This emergency fund would help you get by if you lost your job, got injured and couldn't work, or something very unpredictable blindsides you, like COVID-19 and the resulting pandemic did to many people.
Financial advisors recommend having enough in an emergency savings account to keep you going for at least 6 months of expenses.
For example, if you spend an average of $3,000 every month for things like rent, groceries, insurance, and utilities, you should have an emergency fund of at least $18,000 ($3,000 x 6 months).
Before you begin stock investing, you should have this emergency fund. Stocks cannot necessarily be turned to cash easily, so it is important to have enough cash to pay for emergency expenses.
It may be hard to imagine an emergency happening, but preparing for one can be the difference between surviving a disaster and preventing financial ruin.
Once you have this, you can then begin considering building your investment portfolio.
Investments and savings both contribute to your "nest egg" of wealth, but they are not the same. Understanding the two and how both of them should be used can help you decide which one you should be focusing on.
Savings is the cash that you readily have on hand that you can access for various expenses and other purchases. Your savings can be kept in a savings account or some other account that keeps your money safe and may earn a small interest rate.
Savings can also be put aside to pay for things like education, retirement, a vacation, or any other purchase you are working towards.
Savings are helpful for providing a crash pad for you in case of emergency as we mentioned above. They are also helpful for working towards your various financial goals. You can budget your money and put away some savings each month to get closer and closer to your savings goal. Short term, your savings won't fluctuate like investments do, which provides stability.
In the long term, savings barely change in value, which is both good and bad. If you put $10,000 in a savings account, 10 years later you will still have $10,000 plus some interest. This is good because it minimizes fluctuations and keeps the value of your money steady.
However, it's also bad because inflation will eat away at the spending power of your money. Just like $10,000 was worth more in 1980 than in 2021, so too will $10,000 be worth more in 2021 than in 2060. This is one reason why people turn to stocks and retirement accounts over the long term.
In the context of this article, "investing" refers to buying shares of a company's stock in the stock market. Each public company (Amazon, Apple, and Walmart, for example) has stock prices for their shares that investors pay for in order to buy a "share" or a piece of that company.
Investors buying stocks are hoping that the share prices increase over time, giving them a "return" or a profit on their initial investment when they sell their share. For example, if you own a stock that has a price of $100 and after 1 year the price is $110, you will have a return of $10 when you sell the stock ($100 from your initial investment + $10 of price growth).
Institutions like hedge funds and mutual funds use investing to make money as a normal business would. Individual investors typically use stocks as long-term investments to help pay for things in the future like retirement or a child's education. Someone investing for retirement may but down $10,000 in hopes that it will grow over many years, which is something savings cannot do very much.
Investors investing in the short term are typically holding a stock for a year or less. Short-term investors try to take advantage of short increases in stock prices to make a profit. However, many of the people that successfully do this are seasoned professionals, and even then very few people are successful at it.
In the short term, stocks are very volatile and can have huge price swings that seemingly move at random. Stock prices tend to be hugely influenced by news or earnings reports from the company, and these are things you can't really take advantage of since they are unpredictable.
Because of this, you must have a very high-risk tolerance as you could lose a lot of money trying to make money with stocks in the short term. As such, stock trading in the short term is not for beginners.
Further, the profits you make from stocks in the short term (a year or less) are taxed very heavily. These are called short-term capital gains taxes and are much more than long-term ones.
A long-term investment strategy is one that uses stocks and other investments to help grow a portfolio over a long period of time. Long-term investing can be very fruitful thanks to the wonders of dividends and compound interest.
Over the last 80-100 years, the "stock market" or, more accurately, the stock market index, has gone up. Throughout this time though, there have been "bear markets" or times where the stock market drops a large amount, like during the Great Depression, the 2001 stock market bubble, and the 2008 financial crisis.
However, after all these crashes the stock market has always come back strong and has surpassed its old levels.
Based on history, if you leave your money in a diversified portfolio (more on this later) for 20-40 years, you are likely to have made a significant return. But as with all things to do with investing, you're still gambling that history will prove out.
We've gone over some of the basics of investing, but should you invest your money in stocks?
While the financial decision is ultimately up to you, here are some things to consider before you make that decision.
Do you think you are ready to invest in stocks but are you worried about safely doing it? Here are some things you can do to minimize your risk and make smarter investing decisions.
Overall, investing can be a great way to meet some of your very long-term financial goals like retirement or education for your children. Allowing the effects of compound interest to create a snowball of wealth for you over a few decades can really change your life.
However, the stock market can be very volatile and you can lose a lot of money if you try to quickly get rich through investing in the short term.
Prioritize creating an emergency fund before you consider investing. Once this is taken care of, then consider some investment options to create wealth for you in the long run. Before you make an investment choice, consider some of these questions so you can make an informed decision:
In the end, the choice to invest or not invest is your choice. If you work hard to understand what you're investing in, and how those investments can mature into the goal you set, you should feel secure about where you've put your money.
If, however, you're thinking about investing because an advertisement from an online broker is causing you to worry you're missing out on a wondrous money-making opportunity, it's time to step back and really think about what you're about to do and why.
In the end, it's about asking questions, understanding what you're getting into, and knowing the risks. You can also look into other types of investments, such as bonds, in case investing in stocks seems too risky for you and your goals. If you still have questions, many brokerage firms have financial advisors that can help you understand more.