Is Stock Market Investing Right for Your Savings?
Worthwhile or volatile? Is stock market investing the right choice for you? Here’s what investors need to know.
Did you know that 55% of Americans own stocks? It makes sense—after all, if you’re saving for your future, savings accounts just won’t cut it. The average return on savings accounts is a meager $0.09, or 90 cents for every $1,000 you deposit. Stocks, on the other hand, have an average annual return of 10% over the last century.
But is stock market investing right for your savings?
Let’s take a look at how stock market investing works—and how you can make the right choice for your financial future.
How Stock Market Investing Works
While we refer to the “stock market” as if it’s a single market, it’s actually a collection of stock exchanges scattered across the globe. The Standard & Poor 500 or the Dow Jones Industrial Average are both examples of such exchanges.
In these exchanges, investors and traders buy and sell shares of publicly traded companies, called stocks. A stock represents ownership equity in a company, which gives the holder voting rights as a shareholder plus the right to a portion of corporate earnings as capital gains or dividends.
Here’s the catch: unlike groceries, stock prices fluctuate all the time. They may even fluctuate within the same day.
How Share Prices are Set
Share prices are set in a variety of ways—it depends on the company and the market. The most common is through an auction process where buyers and sellers place bids. If the price a buyer wishes to pay matches what a seller is willing to accept, they make a trade.
Simple enough, right?
Here’s where it gets complicated: the market is made up of millions of investors. All of them have their own ideas about what a stock is worth, and all of them influence the price based on what they’re willing to pay. You see this reflected in ups and downs in the stock price.
A stock exchange is a platform for conducting such trades. The average investor does not participate personally, but rather through the services of a stockbroker, who performs these trades on their behalf.
If you remember the laws of supply and demand from high school economics, think of the stock market as a real-time, to-the-minute example of supply and demand in the real world. The rules are simple: if there are more buyers than sellers, a stock price trends up, but if there are more sellers than buyers, the price trends down.
How You Earn Money on Stocks
This is important to understand because it affects how you earn money on stocks.
A stock is not a rental property. It doesn’t generate income simply by virtue of you owning it. You only earn money on a stock when you sell it, kind of like buying and selling your home.
The catch is that stock prices change all the time—in fact, the one thing you can count on is that stock prices will change. The art and science of earning money on stocks is figuring out how to time the market and sell at the right moment to make a profit or cut your losses. This is why the average person needs a stockbroker.
How Do You Invest in Stocks?
If you own a 401(k), good news: you may already own stocks! That’s because many 401(k) plans include mutual funds, which are often composed of stocks from many different companies.
If you want to purchase your own stocks, though, you have a couple of options.
For beginners, the most common option is a robo-advisor, which is an automated platform that relies on algorithms to automatically make trades for you. This does not allow you to choose your own stocks, but it’s a good way to start for those who are hands-off.
If you want to purchase stocks individually, you can do it through a brokerage firm or through a self-managed retirement account like an IRA. In both cases, a stockbroker acts as a middleman to make purchases on your behalf.
Risks of the Stock Market
As with any investment, there are risks attached to stocks. The biggest one is volatility, or the upward and downward movements of price. Stock markets are volatile overall, but their degree of volatility adjusts over time. Volatility can be seasonal, news-specific, or even event-specific.
This is a two-sided coin. It’s often associated with risk because you can’t always predict when a stock will go up or down. On the other hand, volatility is also the reason why you might see significant gains.
Is Stock Market Investing the Right Choice?
Yes, with a caveat.
Stocks carry more risk than some other securities, but this also means they carry higher reward. The key is to strike a successful balance between risk and reward over time.
Also, stocks should not be the only investment in your portfolio. A healthy portfolio can achieve growth with significant investment in the stock market, but it should also be diversified to protect against dips in the stock market or a bad trade.
Think of it this way: stock market investing is the right choice for your savings, but it’s not the only choice. The best choice for your portfolio is a balanced mix of assets.
Balance Out Your Stock Portfolio
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