Do you like money? Do you like working for money? If you answered yes and no in this order, then read this article. It’s actually good, I promise. A few years ago, I spent a lot of time researching how the stock market works. What you’re getting here is a summary of the most important part, and practical advice that will put money in your pocket.
Trading or Investing
Trading
Imagine riding a high-speed jet ski across the open waters. That’s the excitement of trading. Traders aim to profit from short-term price fluctuations by capitalizing on market inefficiencies. It requires sharp reflexes, constant vigilance, and a comprehensive understanding of market dynamics.
While trading offers the potential for rapid gains, it demands discipline, patience, and the ability to handle increased risks. It’s a thrilling journey, but not for the faint of heart.
You’re trying to buy right before a green arrow and sell right before a red one. To do this, you need to somehow predict where the stock’s price is going to go. And you need to do this in a market where everyone else is trying to do the same.
What determines if your prediction is successful? If it’s luck, then you’re gambling. If it’s skill, then it’s a job.
Investing
Now, let’s board a majestic cruise ship and set sail for the long-term horizon of investing. Investing is like embarking on a leisurely cruise, sipping your favorite beverage and enjoying the scenery. It involves patiently nurturing a diversified portfolio over time, harnessing the power of compounding.
Investors focus on the big picture, recognizing that the market has historically trended upward over extended periods. While occasional market storms may arise, they weather them by staying the course and trusting in the strength of the global economy.
Stocks generally go up. They don’t always go up, and they don’t tend to go fast, but the market tends to increase in value. If you invest right, you will make money from this. As you can guess, this requires way less mental effort.
Compound Interest
Compound interest is a financial superpower that can turn your money into a growing force. It works like a snowball, gaining momentum and getting bigger as it rolls down a hill.
Here’s how it works: When you invest money with compound interest, your initial investment earns interest, and that interest becomes part of your total investment.
The exciting part is that the next time interest is calculated, it’s not just based on your original investment but also on the interest you’ve already earned. Interest on top of interest!
The longer you keep your money invested, the more powerful compound interest becomes. It’s a snowball effect that can significantly boost your wealth over time.
For example, if you invest $1,000 with an annual interest rate of 5%, after the first year, you’ll have $1,050. In the second year, you’ll earn 5% not only on your initial $1,000 but also on the additional $50 you earned in interest. This compounding effect continues year after year, and your money grows faster and faster.
Diversification
Diversification is key to reducing risk and protecting your investments. It’s like having a well-balanced meal with a variety of nutritious foods. By spreading your investments across different asset classes, industries, and regions, you can cushion the impact if one investment performs poorly.
One effective way to achieve diversification is through index funds. These funds are like ready-made baskets filled with a mix of stocks or assets that mirror a specific market index, such as the S&P 500.
Investing in index funds provides instant diversification, giving you exposure to a broad range of companies within the index. Instead of picking individual stocks, you capture the overall market performance.
Even if any individual company goes bankrupt, the growth of all your other holdings will make up for the loss. Law of large numbers.
Not Convinced Yet?
Did you know that 80–90% of investors fail to outperform the S&P 500?
Did you know that the S&P 500 has never delivered negative annualized returns over a period of 30 years?
And most importantly, consider this question: what else could you do with the time you spend researching individual stocks?
Closing Thoughts
I’m not a financial advisor. This doesn’t mean I don’t trust in my own strategy, but apparently if I don’t have a disclaimer like this, you can sue me or something.
Oh yeah, you can technically lose all your money in the market. But you can lose it to inflation if you keep it uninvested, or you can spend it all on bubble gum. You’re smart enough to know the risks.
This article was written clearly advocating for a certain strategy. Follow me if you’re interested in a more informative article I have in the works that helps you understand how I’ve come to this conclusion.