Since embarking on my personal finance journey, I have focused a lot on stock market investing. Partly because they were the first form of investment I was introduced to as an adult. Partially because it allows you to earn a part of a tangible company, allowing the investment to feel real. But mostly because they are extremely accessible, easy to track, and simple to maintain.
I have spent many many days’ worth of time researching the stock market, reading about the stock market, listening to podcasts about the stock market, and investing my own funds into the stock market. Despite the entire market jumping off a cliff since I started investing (very similar to the image above), I feel that I have learned a lot about how the stock market behaves, and seen the effects of one of the most important rules of investing first hand (more on that later).
I can only hope that at least some of this information will be useful to at least one person out there. You may read this and say “I knew all of this from day one”. Well, congrats. Stop talking out loud in response to a blog, but congrats. Regardless of that guy’s attitude, I hope to help you learn more about stocks. Either beginning or continuing your journey to financial independence.
Click to jump to a section:
- WTF Are Stocks?
- But Why Risk It?
- One of the Most Important Rules of Investing (IMO)
- Dividends on Dividends
- Where to Buy Stocks?
- Where to From Here?
Stocks are one of the most accessible forms of investments, and yet are not taught in schools, except for in overview finance electives in school. The history of stocks has served to make the rich richer, and convince everyone else that stocks are too complicated to understand. This is a pattern that with today’s technology and online brokerages can be broken.
WTF Are Stocks?
Stocks are pieces of companies that are available for purchase, with public stocks being available on the stock exchange, usually purchased through a broker. To purchase a piece of stock, you purchase a share of a company, which is a very small piece of a company. This means that if the company is performing well and people are happy with the performance of the company as well as their perceived future performance, then they will purchase more shares, driving up the price.
Prior to learning about the stock market, I thought the same thing that most people think. The stock market is a meaningless amalgamation of graphs where people bet their money with the same probability of winning as a horse race. But this just isn’t the truth.
First, the price of stocks is driven by supply and demand. Each company only has a set number of shares on the stock exchange. Thus, if the company shows promise like beating its projected quarterly revenue by 10%, and more people will want to buy the company, the price of the shares will increase since demand increased with supply staying stagnant. This of course works in the reverse where if people think that a company is about to experience a downturn and sell their shares, the price will drop as there is now less demand with the same supply.
But Why Risk It?
If you think this all still sounds risky and meaningless, I get it. Any form of investment is risky, save for maybe putting your money in a government-backed bond. However, we can use historical data to get a picture of what will likely happen. Over the last 100 years, the primary stock market index, the S&P 500, has had an annual return of 10.49%, 7.38% adjusted for inflation (Source: officialdata.org). To be clear, these are the returns for an index automatically tracking the top 500 companies in the stock market. This index is available publicly on the stock market, charges ~.03% fees depending on the fund you choose (I use ticker VOO), and requires zero input. Simply throw your money in and let it ride. This is not the type of stock market you see on TV where people are making dozens of trades a day, researching companies for hours, and analyzing a hundred data points on a chart.
Please understand that past performance is not an indicator of future performance. However, when we have historical data of over 100 years, through world wars, recessions, massive bankruptcies, etc. and the market still returns >7% annually after inflation, that is massive. To put this return in perspective, you could double your invested money once every ~7 years. Again, with zero input on your end past depositing money and purchasing shares along the way, which can all be automated.
For even more in-depth reasons to invest, check out my Five Reasons to Invest in the Stock Market post.
One of the Most Important Rules of Investing (IMO)
Here is how most people act when the market drops. Either they pull their money out, scared of losing their money, causing the prices to fall even further, or they wait to invest more, telling themselves they will invest more when the recovery begins. We can prove both of these mindsets wrong.
First, and more easily proven, pulling your money out when the market is down causing you to directly lose money. When you invest money in anything, and the value of that investment drops or increases, you have neither lost nor gained money. It is only once you “realize your gains/losses” by selling your investments that your actual amount of funds changes. In the case of stocks,
this means selling your shares. However, if when the market drops you hold onto your funds, you can wait until the market completely recovers or even surpasses recovery to pull out. You may not even want to pull out at this point, but at least this way you never realize your losses, only gains or neutral.
Second, the idea is that you should wait to invest more until the bottom (shown above). In a perfect world, you could time the bottom and invest a massive amount of money at every bottom of the market. However, this is unachievable even for professional traders and money managers. The more effective method of investing is “dollar cost averaging”, which is the method of investing a fixed amount of money into the market at fixed intervals regardless of market behavior. For example, investing $100 on the first of every month no matter what. This may sound too good to be true, but it’s not. Let’s run the numbers. Say you have $100 in the market, and it drops 20% to $80. Two months later, it increases by 25%, fully recovering to the initial $100. Alternatively, if your portfolio dropped from $100 to $80 again, but you invested an additional $100, you would now have $180 in value at the bottom. This time, once the market recovers by 25%, you will have $225, $25 more than you have deposited.
This methodology essentially tells you to constantly be adding money into the market, allowing you to follow the average price of the market, hence “dollar cost averaging”. Whenever the market falls, you “average down” the average cost you have paid for a stock. I have followed this methodology since early 2022, and I have seen the benefit of investing like this. Since I have been averaging my cost down this entire time, whenever the market recovers to say 15% below its late 2021 peak, I am only down 10% or 11% from late 2021. Eventually, due to continuing to dollar cost average, whenever the market fully recovers, I should be up by a substantial 5-7%. As opposed to the person currently waiting to put money in since the market is so far down, who will be at breakeven when the market recovers.
If you want to learn more about dollar cost averaging, I strongly recommend The Investing for Beginners Podcast. Andrew Sather talks a lot about dollar cost averaging, and I have implemented it heavily into my investing style.
Dividends on Dividends
One last topic I want to cover in this introduction is dividends. Think of dividends as payouts from companies to people holding shares of their stock, in exchange for those shareholders taking the risk of holding their shares in the first place. Not all companies pay out a dividend, either due to not having enough profit to afford to do so, or, preferably, reinvesting that money back into the business to improve profitability. The percent yield of a dividend is the dividend’s amount divided by the price of one share. For example, if a company pays a $4 dividend and the cost of one share of their company is $100, the dividend yield is 4%.
Though these sorts of single-digit percent yields usually below 5% don’t sound exciting, remember that this is on top of the growth of the company itself. For another example (let me know if this is too many), if a company whose share costs $100 paid you a 4% dividend, and the cost of the share increased by 5%, you have now made a 9% return on your investment.
Reinvesting dividends (aka DRIP, Dividend Reinvestment Program) means taking those dividend payouts and automatically using them to purchase more shares of the company. So in the example of a $4 dividend payout, you would now own 1.04 shares of that company, instead of just 1.00. Again, while this may sound minute, when you compound this over years and years along with stock growth, your gains are magnified (hence, “dividends on dividends”). Next time they pay a dividend, you are getting dividends for 1.04 shares instead of the previous 1, paying a $4.16 dividend. Even in the case of a downturn, if the amount of the dividend stays the same or increases (dividend amounts usually stay the same or increase as they are based on a fixed amount, not percent) you now own more and more of that company, allowing for an even larger return once the stock recovers.
A final note on dividends is that most solid companies that pay a dividend increase the dividend quarterly or annually, many times by 10-15%, assuming the company is still growing. The company is giving you, the shareholder, a better raise than you get working as an employee at most of these companies!
In the near future, I will be posting a dividend-tracking spreadsheet I have been developing. So check back weekly to get that when it drops!
Where to Buy Stocks?
To purchase shares of stocks, you must use a brokerage. A brokerage is basically a company that will allow you to deposit money, and use that money to buy shares of stocks. The vast majority of brokerages nowadays allow you to buy fractional shares so you don’t have to pay for an entire share at once (necessary for dollar cost averaging), and charge very small or no fees.
Two brokerages I recommend are Robinhood and Fidelity. Both platforms are fantastic and allow for automatic deposits and investments, but I personally prefer Robinhood. This is primarily because it will give you a percent gain or loss in your portfolio ignoring deposits. On the other end, on Fidelity, if I deposit $100 one day, it will say that my portfolio has increased by $100 and x%, even if all of my stocks haven’t moved. I am in no way sponsored by Robinhood, but they do have a referral program. If you choose to go with Robinhood, use my link to signup, and we will both get part of a share of a chosen stock. However, before you select a brokerage, look up what they offer and choose what feels comfortable to you. As long as it allows for fractional shares and doesn’t charge a fee, it doesn’t make much of a difference.
Where to From Here?
Next week, I will be posting on buying and selling stocks. I am not a professional broker or day trader, but there are foundations for selecting stocks that everyone can use. If this sounds excessive to you, there is nothing wrong with simply buying VOO (index fund to follow the market) every week or month and letting it ride. This will likely earn you a fantastic 7-10% return annually on average, with very little effort. Again, if you decide to use Robinhood you can use my link to get started with a free stock.
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