It changes night and day and gives people nightmares when they follow it but can also lead them to riches. What is it? The stock market! Long heralded as either the bull that brings in extra bread or the bear that can wreak havoc on one’s investments, the stock market’s volatility can bring riches or ruin. Read on to know more about investing in stocks.
The key to achieving the former without the latter is understanding how stocks can earn you money so you can take advantage of different trading strategies, whether to diversify your portfolio and minimize risk or choose the stocks that can earn you the greatest return on your investment.
The following trading strategies are core principles related to how investing in stocks can make you money.
Short-term trading/ Day trading
Before delving into stock trading strategies, there are two key points to consider when trading. First, owning stock is owning part ownership in a company; the more stocks you own, the more powerful your voice is in company meetings.
Depending on how you wish to invest and what resources you have at your disposal, you can choose to invest heavily in companies that you feel have the greatest growth potential or spread your assets throughout different stock classes and companies.
The important thing to take note of is that stock for a company that goes bankrupt essentially loses its value. So, it pays to choose the right companies when buying stocks. When it comes to avoiding potential long-term losses relative to company vitality, day-trading has an advantage over other stock trading strategies.
At the same time, taxes you pay on capital gains achieved from sales of stocks will vary based on how long you have owned that stock. Stocks held for less than a year will be taxed according to your income tax bracket, anywhere from 10-37% of the value of the stock.
Stocks held for a year or longer will be taxed from 0-20%. In summary, you pay less in taxes for stocks sold when you hold them for longer than a year.
Depending on the volume of stocks you are trading, the potential yield, and what the potential tax is, it may or may not be worthwhile to invest in short-term trading vs. long-term trading.
What does it take to succeed in short-term stock trading? A brief summary of what it takes to succeed as a day trader:
. You need sufficient time each day or even during the day to make sufficient trades since the whole point of day trading is buying and selling stocks to maximize the highest return and the lowest purchasing price.
. You need to sufficiently research companies to determine what their trading volume and liquidity is which influence how many shares will be available and the price per share as well as the potential return on investment based on how many shares you purchase.
. You need to have sufficient investment funds and be aware that you shouldn’t be willing to lose more than 1-2% of your funds for any trade.
For beginners, it’s best to start slow and work your way in as you become more familiar with how day trading operates. Identifying companies with higher market capitalizations and greater liquidity offers greater potential to earn a solid return from short-term trading.
Growth stocks
For those not interested in committing to short-term trading or willing to ride out long-term investments, investing in growth stocks offers another pathway to sufficient returns.
When determining whether and how to invest in growth stocks, you first need to set aside a certain amount of investment income, recommended to be 10-20% of your disposable income.
Growth investors are also cautioned to have a long-term approach to be ready to “ride the wave” of price increases and drops while also being able to purchase stocks when the market drops.
Investors can choose to invest in specific growth stocks or in specific funds, though funds will be addressed momentarily. When choosing growth stocks, companies with stable management, consistent growth, and relatively high market capitalization (shares available) provide greater opportunities for consistent gains realized over long-term investment.
Dividends
Depending on how a company grows and how well it grows, different possibilities exist with regard to the stock itself. Stocks can be split, bought back or dividends can be offered.
Stock splitting and buy-backs are less predictable at the outset given that they are dependent on how well a company is doing, but dividends are usually offered as a condition of buying a stock.
Dividends can come in many varieties, but the general form is a quarterly or annual payment, in either cash or other stock, to the owners of the stock.
Dividends are usually representative of strong earnings and a reflection of company health as well as the value of the stock. Dividends require owning the stock for a certain period of time, however, in order to earn the dividends for that stock (usually at least a year).
Buying stocks with dividends offer another long-term growth opportunity, especially when purchasing more expensive, growth-oriented stocks that can provide a constant return without having to sell the stock.
ETFs
Exchange-Traded Funds, or ETFs, are a compilation of different stocks, bonds, and other assets that are traded collectively. They typically mirror a specific index, such as the S & P 500, and don’t have restrictions on holding periods.
Likewise, because they aren’t traded as heavily there are fewer taxable transactions relative to owning an ETF, with taxes only being paid when an ETF is sold. ETFs offer greater diversity while reaping the benefits of owning stocks over a broad market index.
Mutual funds
Mutual funds are similar to ETFs in that they can contain a broad array of assets, typically stocks and bonds.
One of the key differences is that a mutual fund is typically managed by a fund manager, so all asset selection is dependent on a third party; depending on the skill of the manager, your fund may do well or not.
Likewise, fund managers charge varying commissions based on yearly portfolio maintenance, adding to the expense of investing in a mutual fund.
That being said, mutual funds are naturally diversified and can incorporate a variety of stock classes, from small-cap to large-cap, growth to value stocks, making them less risky than investing in individual stocks, particularly for passive, long-term investors.
Index funds
Index funds have gained a solid reputation as a reliable, long-term growth strategy. Index funds operate similar to ETFs with regard to tracking a specific index, though index funds typically concentrate solely on stocks while also offering the ability to diversify within and across different indices.
Essentially, the diversity and comprehensiveness of an index fund reduce the volatility of individual shares while also increasing the long-term gains relative to the growth of the stock market.
These are just some of the many considerations and possibilities with regard to investing in stocks. Proper research, sufficient reserves, and clear investment goals are critical to making the proper stock selection to help your assets keep on growing.
