How to invest in the stock market - a guide for beginners with a little cash to spare
Your returns will be much greater if you put money into stocks than if you leave it in a saving account at a bank
Just got your first bonus? Congrats! You've worked hard for it. Being flush with cash feels great. Now what? Well, first, do treat yourself a bit. Those bills are just some high production value paper if you do not spend them. But don’t blow all of it away; future-you will be thankful for the money you save and invest today.
You may have heard about "interest rates" in the news. Interest is what banks pay you for depositing your money, which they then lend to other people for a higher interest rate.) Interest rates fluctuate depending on how the economy is going, which influences the policies of leading financial institutions such as the International Monetary Fund and the US Federal Reserve.
But even though banks are paying you to keep your money there, the rate they pay you on your savings is is very low. So, what can a wise money manager do to improve upon those miserable returns? Consider investing. But this doesn't mean you should spend your entire bonus on Apple. Picking stocks that will be successful – that outperform the broader market – is notoriously difficult. There is a lot out there to read about investment strategies, but the fact remains that even professional money managers have a dreadful record when it comes to sustained investing success.
It is extremely hard to predict the future, and it is even harder to overcome the psychological biases that will push you to buy stocks when the market is exuberant and overvalued – you will likely want to jump in on the action – and then to sell them at a loss just as the numbers start to drop across the spectrum.
Thankfully, you need not beat the market to make money – you can simply track it. Warren Buffett, arguably the most successful stock-picker of all time, advises that small investors buy into “index funds” to generate long-term returns. Index funds, pioneered by the late fund management legend Jack Bogle’s Vanguard Group, maintain a basket of stocks designed to copy the broader market – be that the S&P 500, The Dow Jones Industrial, funds linked to Britain's FTSE, or the Hang Seng Index. Because these funds are passive, as opposed to active funds in which managers make stock-picking decisions, fees tend to be really low.
Investors should always be aware of the fees they may incur when they make forays into the market – particularly with actively managed funds, this can be the difference between making and losing money. They can be blisteringly high, so once you find out the fee, retreat to do your maths.
In the very long run, the stock market has returned about 7 per cent a year, when dividends are reinvested. Of course, that certainly does not mean you will make 7 per cent every year, nor does it even mean that the market will return 7 per cent in the future more generally.
If you choose to get into index funds, when should you do it, and how? Much as picking stock market winners is a treacherous business, so to is timing your entry into the market.
Therefore, consider dividing your potential investments into 12 equal portions, putting one portion into the market each month. This is know as dollar-cost averaging, and implies that you will buy fewer shares when the market is expensive, and more when the market is cheaper. As a result, you avoid the risk of entering the market at the top, and your average entry price is mathematically lower than the market’s average price.
Yashvardhan Bardoloi is an Applied Math and Economics student at Harvard University in the US. He interned as a Summer Investment Analyst at Goldman Sachs.
This article was curated in conjunction with Young Post.