There are 3 things to understand about investing if you want to make money in the stock market
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- Learning how to invest in stocks doesn't have to be complicated.
- The best place to start investing is typically in a retirement account, using low-cost index funds or a robo-advisor.
- Three factors affect how well your portfolio performs in the stock market: How much you invest, how long you invest, and your rate of return.
- To minimize risk, diversifying your investments across different types of companies, industries, and countries is key.
But the reality is many people, especially younger Americans, don't invest. Millennials are the only generation to favor cash over investing in the stock market, according to a Bankrate survey.
After all, investing your savings in the stock market, rather than keeping all of it in cash, could amount to a difference of up to $3.3 million over 40 years.
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Luckily, investing isn't as complicated as it seems. According to ESI Money, there are three factors that determine how well your investments will perform:
1. Your timeline
ESI Money crunched the numbers and found that time is the most important factor in how well your investments perform. "[T]he longer you wait to save and invest, the more you're costing yourself," he said.
In other words, it's all about maximizing the benefit of compound interest.
Take a look at the chart below, which illustrates the difference in savings for a 15-year-old who puts $1,000 of their summer job earnings into a Roth IRA - a retirement account where your savings grow tax-free - for four years and then stops, and a 25-year-old who puts away $1,000 until age 28 and stops.
Assuming a 7% annual rate of return, the early saver will have nearly twice as much money saved by age 65 as the late saver, with no extra effort whatsoever. Even if the late saver continued putting away that same amount until age 30, they'd still come up short.
Andy Kiersz/Business Insider
The best way to maximize earnings is to keep saving and investing consistently, but the idea remains: The more time your money has to grow, the more you'll likely end up with.
2. How much you invest
How much money you earn in the stock market will be based partially on how much you invest. The good news is that you don't have to invest a ton of money to earn a lot over time. You can easily start by contributing 15%, 10%, or even 5% of your pre-tax income to a retirement account, like a 401(k) or IRA.
If you're worried about investing too much money for fear of losing it, don't. Stock market investors had over a "99% chance of maintaining at least their initial investment" - the same as a traditional savings account, according to a NerdWallet analysis of 40 years of historical returns.
3. The return rate
The NerdWallet analysis also found that investors had a 95% chance of earning nearly three times their initial investment, while traditional savers had less than a 3% chance of tripling their investment.
Still, the rate at which your money grows is completely out of your control. That's the nature of the stock market - not even legendary investor Warren Buffett can guarantee big returns.
Ultimately, you're doing well if your investment outpaces inflation, which won't happen if your money is shored up in a bank account with low interest rates. To minimize risk, diversifying your investments across different types of companies, industries, and countries is key.
Another increasingly popular tool for novice investors are robo-advisors, which use an algorithm to build and manage your portfolio for a low annual fee. Just make sure you're not paying annual fees higher than 0.5% on any "low-cost" investment account or it'll eat into your returns. Wealthfront and Betterment can be good fits for people who want to start investing with small portfolios and "set it and forget it."
ESI Money sums up the winning formula best: "Save early, save often, and save more as time goes by."
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