How do you grow wealth in America? Back in the day, it was supposed to be hard work that turned regular folks into millionaires and billionaires. And, sure, that’s still a pretty important part of the equation for many people. But here’s a harsh truth: For most of us, hard work and diligent saving are not enough to build real wealth.
Why? It’s because our money loses its buying power over time. When we stash our money under the mattress, we’re robbing from ourselves. When we pull it back out again, it will be worth less than it was when we earned it. It’s called inflation, and beating it is at the center of most wealth-building strategies.
And the best way to beat it? You guessed it: stocks. You have a lot of ways to get more out of stock investing and build real wealth, so let’s talk about some of them here. This is your crash course in getting wealthier through the power of stocks.
The basics: why stocks are better than other options
First things first: why stocks? Simply put, the stock market lets you buy shares in companies and enjoy their increases in value (or suffer along with them when they lose value — we’ll be trying to avoid that part). Generally speaking, the stock market is the best way to build wealth because you’ll earn gains on your investments more quickly than you with other typical options: the stock market will beat savings account interest rates, for instance. A typical long-term stock market interest rate (assuming a fairly conservative strategy) is 10 percent annually. Even the best savings accounts can’t match that — you’ll be lucky to find a savings account that will give you even 1 percent annually.
Convinced? Good. Then let’s talk about how to maximize your earnings in the market.
Using tax-advantaged accounts to build wealth
One of the most important things that you can do to maximize your returns when you invest is use tax-advantaged accounts. You can find the IRAs and 401(k)s that the government will let you put money into and pay fewer taxes on. Traditional IRAs, for instance, allow you to put money into them and then not count that money as income on your taxes that year. You will withdraw that money when you’re much older (if you dip in early, you’ll pay penalties) and will pay income tax on it — which, if you’re retired and not earning an income, won’t amount to much. You have other types of tax-advantaged accounts, of course: with Roth IRAs, you pay taxes on the money now but won’t later, and you have non-retirement options such as health- and education-specific accounts.
Buy and hold: using safe long-term strategy
OK, so you’re investing, and you’re doing so (partly, anyway) in tax-advantaged accounts. Now, what are you buying?
One simple and safe way to start investing is to put money into index funds, which track large market indicators. For instance, a Dow Jones index fund will have its own value pegged to that of the Dow Jones index, which is made up of a bunch of big companies. When the market goes up, your investment will gain value. Simple as that!
Or, you could invest in a diverse portfolio of stocks you believe in yourself. This takes a bit more research, but you can always enlist the help of a financial adviser.
Either way, this first strategy involves buying these safe bets and simply holding onto them. Within reason, you won’t sell for anything. You’ll just keep holding that stuff and then when you retire or need the money, you can cash out.
This strategy works because the market tends to go up over time, and it makes sense because most people who try to “time the market” — that is, sell stocks and peak value and buy back in on the cheap — tend to mess it up. They may still make money, but they may not “beat the market,” which means they may not make as much as you’ll make simply by buying and holding through thick and thin.
Getting bolder and more complex: options and how they work
Of course, not everyone wants to just buy and hold. And there is no denying that, with enough financial savvy, you can make far more on the stock market with a more aggressive strategy. Just remember that an increase in potential profits comes with an increase in risk! Don’t bet more than you can afford to lose.
If you do want to become a more “active investor,” you’ll want to stay abreast of the market news and rely on trusted sources such as The Wall Street Journal, CNBC, Bloomberg, and other financially minded news sites. And you’ll want to learn how to read earnings reports and analyze the value of a company and its stock.
If you’re confident that you know whether, how much, and in which direction the value of a given stock will move, then you can use call and put options to make leveraged bets on the market. With the power of options, you can bet against stocks as well as on them. You’ll add a whole new dimension to your trading strategy!
You can get as deep into stocks as you’d like, or you can use a simple buy-and-hold strategy. But know this: Stocks are key to building wealth!