Every so often I’ll be with someone who will talk about investing in the stock market and how it is just really gambling. I usually nod along and smile, not really wanting to get into a big debate. I guess that you can use the stock market to gamble, but stock market investing is not gambling.
When you gamble, the odds are not in your favor. When you plant some seeds in your garden with the intention of watering them and taking care of the plants as they grow, it really isn’t a gamble whether or not you will have fresh vegetables later in the summer. When you buy a home, it really isn’t a gamble whether or not you’ll have some equity built up and the home will have appreciated at least at the rate of inflation in 30 years. Bad things can happen. There are some extreme occurrences, but most of the time, things will work out in your favor, at least to some degree.
Now you could turn these things into gambles. You could just throw some seeds down and do nothing else, seeing if they will grow or if the birds will eat them before they sprout or if the rains will come at the right times. You could buy a house for a year, then sell and buy another one the next year, continuing this for twenty years, and see what you end up with at the end. In both these cases, the odds are not in your favor. This is not because of the seeds or the houses, but because of your actions. You weren’t doing what was needed to put the odds in your favor.
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Investing in the stock market also isn’t a gamble, if you actually invest. You could just pick a stock or two and then plan to sell them at the end of the week or the month. Chances that they would be up are about equal to chances that they would be down. If you really invest, however, you put the odds in your favor. There is a chance that things won’t go well – a very slim chance – but most of the time things will work out and you’ll end up with a decent return when compared to other things like bank CDs and even real estate.
So how do you invest, as opposed to gamble, when investing in the stock market? Well, there are a few things that you do to put the odds in your favor:
1. Plan on staying invested for a long time. I can’t say whether the market will do well over the next year. But I can say that the markets will increase over the next twenty or thirty years.
2. Stay the course. You never know when the big market upturns will be, but if you buy and stay invested, you know that you’ll have your money in the right place when those big moves up do occur. Most investors lag the returns of the markets because they get scared and sell out at just the wrong time, then they get overexcited and buy just at the wrong time. Accept that you cannot predict short-term movements of the markets and stay the course.
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3. Buy index mutual funds. Diversification – owning a lot of different investments – ensures that you’ll be invested in whatever is doing well at any given moment. Index mutual funds allow you to spread your money across dozens or hundreds of companies and do so with very low costs.
4. If you buy individual stocks, pick companies that look good long-term and plan to hold onto them. It is nearly impossible to predict which companies will do well over the next year for the same reason that it is impossible to predict how the markets will do. It is possible, however, to pick companies that will do better than the markets over long periods of time since some companies are clearly stand-outs from the pack. If you want to try to buy individual stocks to increase your returns, give them time to grow rather than selling them right when they start to perform or when they drop a bit in price. Buy the business and be more concerned with how the company is doing than how the price of their stock is doing. Plus, put the bulk of your investments into mutual funds, just in case you aren’t a great stock picker.
5. Add to your positions regularly. It is very unlikely that you’ll buy in at just the right time, but if you buy in regularly over a long period of time, you’ll get a good cost basis. It is just the way that the math works since you end up buying more shares at lower prices than you will at higher prices. Set up your accounts to regularly send in a monthly investment to your mutual funds and then just forget about it. Your investments will take care of themselves.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.