Last Updated on 17 November, 2020 by Samuelsson
You may have heard several stories about the stock market: the good, the bad, the ugly, and sometimes, the extremely good. So you may be wondering if it’s possible to become rich from stocks.
Yes, you can get rich from stocks if you start early, think long-term, begin with a sizeable capital, and regularly add to your investment. And the good thing is, you don’t need to know much about individual stocks before you can start investing.
There is more to investing in stocks than buying a couple of shares. In this article, we will discuss the different ways you can invest in stocks, the need for diversification, and other tips for building wealth, but first, you need to know why investing in stocks can help you grow wealth.
Why It’s Possible to Get Rich Investing In Stocks
The stock market is not just a place to make some extra income; it has made several millionaires and even billionaires over the years. As a matter of fact, with the right skills and mindset, you can be on the path to becoming a millionaire.
Although the market is known for its inherent uncertainty, there’s no easier path to riches than investing in stocks. There has been a lot of success stories to prove that, and it only takes one good investment — held long enough — to change your own story.
But you need to understand that it takes time to accumulate wealth. The secret to investing your way to riches lies not in quick flash gains but in the accumulation of market returns over a long time. So, to understand why you can grow wealth in the stock market, let’s explore the following:
Long-term wealth growth: The magic of compounding
As the great scientist, Albert Einstein, once noted, the principle of compounding is one of the greatest wonders of the world — whoever understands it, earns with it, and whoever doesn’t, pays for it. In other words, it’s either you’re building wealth with it (compounding your returns on investments), or you’re paying for it because your money keeps losing value due to inflation.
The principle of compounding makes it possible to earn a return on a previous return in addition to the return on the initial capital. It gave rise to compound interest, which is the interest you earn on both the initial capital and the previously earned interest.
As an investor, you can build wealth with the principle of compounding by reinvesting your earnings — from either capital gains or interest (dividends) — to generate more earnings over time. This leads to an exponential growth of your asset since both your initial capital and the accumulated earnings from the preceding periods generate earnings at any point in time.
For example, let’s assume you invest $1000 in an asset that yields 10% yearly return. By the end of the first year, you would have earned $100, taking your total asset value to $1100. By the end of the second year, the $1100 — initial capital plus the first year return — would earn $110, taking your total asset value to $1210. This means you earned 10% gain ($100) on your initial capital and 10% gain ($10) on your previous year’s return.
If you keep getting 10% return each year, in 10 years, your investment would worth about $2593.74. Compounding is a powerful factor in growing wealth, and time is the key. So, it pays to start investing early.
Although the stock market may be irrational in the short term, stocks of good companies usually appreciate in value over time, provided the company continues to do good business and generate superior earnings.
The market moves in cycles: bull markets are invariably followed by bear markets — when stocks generally decline in value — but good stocks always survive every market condition and keep appreciating in value. Even among the good stocks, some do exceptionally well and are called market winners. Spotting the market winners early enough when they are still relatively unknown is one sure way of becoming a millionaire.
For example, in 1964, a share of Berkshire Hathaway was just about $19, but today, 12th July 2019, it trades at $321,093.00 — you can do the math yourself. During this 55year period, there have been not less than eight bear markets, yet, the company thrived. Similarly, Apple offered its shares at $2.75 in its 1980 IPO; now, a share of Apple trades at $230.30.
The dividend factor
Some good companies regularly pay dividends. A dividend is a reward a company gives to its loyal shareholders mostly at the end of the financial year. Most of the time, dividends are taken from a portion of the company’s earnings for the year but must be decided by the board of directors, or the shareholders.
Most dividends are issued as cash, but can also be issued as shares of the company’s stock or another property. When issued as cash, an investor can decide to use it and buy more of the company’s stock, or shares of other companies.
So, dividends play a great role in long-term wealth building. It can be regularly reinvested, and over a long time, this can compound to huge effects, maximizing the returns on investment.
The Warren Buffet Example
If you’re still in doubt of the possibility of getting rich by investing in stock, here is a well-known example of someone who got extremely wealthy through the stock market. You must have heard about him; he’s the second-richest man on the planet, according to Forbes in 2019, and easily the most popular stock market investor of all time.
Often called the Oracle of Omaha, Warren Buffet started his journey in the stock market at the age of 11 when he bought six shares of Cities Service preferred stock at $38 per share. The stock would eventually rise to $200 per share after an initial decline to $27 per share.
As a teenager, he was delivering Washington Post newspapers and was making about $175 each month, most of which he saved. He also made money doing some other business, and by the time he graduated from college at the age of 21, he was worth over $20000, 65% of which he invested in GEICO insurance.
After working in Ben Graham’s (his mentor) corporation for two years, he formed several partnerships to raise money. In 1962, he discovered a textile company, Berkshire Hathaway, which was selling below $8 per share and started buying the stock. By 1964, he became the largest shareholder of Berkshire Hathaway and eventually took over the management of the company. Now, the stock trades at more than $320,000 per share.
How to Grow Rich Investing in Stocks
One of the most interesting things about investing in stocks is that it doesn’t require any qualification, and you can start any time with whatever you have and grow from there. If you’re still in your twenties and thirties, starting your investing journey now may be the best decision of your life.
Although some brokers require that you have a certain amount before you can open a brokerage account, there are many that will allow you to open an account with $0.0 provided you’re committed to depositing something every month. Just search around, you will definitely see a broker that suits your needs.
Before you start investing in the stock market, you need to understand the type of investor you want to become, as that will decide the way you interact with the market. There are different approaches to investing — active investing and passive investing. Let’s explore what they mean so you can choose the style that suits you.
This implies being actively involved in buying and selling of stocks. That is, you will be the one to select the stocks to buy, decide when to buy them, and manage your portfolio of stocks. To do all of these, you will need to learn how to analyze stocks using both fundamental and technical analysis strategies.
Fundamental analysis means evaluating the performance of the companies behind the stocks to assess their real value and their potentials for long-term growth. Some investors are more interested in a company’s potentials for growth and are called growth investors. Others like Warren Buffet look for profitable companies that are temporarily selling below their real value, and they are called value investors.
Technical analysis involves analyzing previous price movement of a stock to ascertain the most likely direction the price will go in future. Followers of technical analysis make use of price patterns and technical indicators in their analysis, and they mostly don’t keep a stock for a long time.
With this approach to investing, you don’t need to bother about learning how to evaluate stocks. You simply invest your money and forget about it for a long time. Your investment keeps growing while you do something else.
There are three common ways to invest passively: traditional mutual funds, exchange-traded funds, and index funds. Investing in traditional mutual funds means that you’re buying into a basket of stocks managed by a portfolio manager.
Exchange-traded funds are baskets of stocks which trade as a single unit. You can buy them just like stocks. Some track stock indexes and are referred to as index funds. It has been shown that index funds perform better than most mutual funds and require less commission than mutual funds.
For instance, if you invested only $1000 in 1980 on an index fund that tracks the S&P 500 index — which has been making an average yearly return of about 10% — it would presently be worth about $41,144.78. Now, imagine putting away $1000 in that investment vehicle every year from that 1980 till date or $10,000 the first year and then just $1000 yearly — you can do the math.
Research has shown that index funds would over time almost always beat a typical investor who invests actively. Passive investing saves you on commission and taxes since the investment is left for a long time.
The Importance of Diversification
Whether you choose to invest actively or passively, one thing you must have at the back of your mind is how to minimize risks, and that is what diversification is all about. Diversification is a strategy to manage risk where a wide variety of assets are included in the investment portfolio. The rationale is that when one asset is performing badly, the good-performing ones will neutralize the effect.
This is probably why index funds and ETFs perform better than the typical active investor. By tracking a basket of stocks, these funds are inherently diversified. Nevertheless, even if you’re invested in an index fund, it pays to have some money in other asset classes too.
If you are an active investor, it is very important to avoid stocks that are closely correlated because they tend to respond the same way to market forces. When there’s a negative market event, the losses can be catastrophic. One rule of the thumb is to avoid stocks in the same industry or offering similar services. Furthermore, it’s necessary to invest in other assets, such as bonds, REITs, and commodities.
Tips for Building Wealth
The following tips may help you in your journey to creating wealth.
Have a long-term outlook: You are probably not going to get rich overnight, so it’s necessary you have the right mindset. Building wealth is a long-term goal and requires patience.
Invest in yourself: It pays to invest in yourself. Improve your skills so that you can earn more either from promotion at your current job or getting a better paying job. You can learn new skills too.
Save daily: Make sure you’re saving some money each day no matter how little. Saving just $5 a day amounts to $1825 each year. When you save, you’ll have more money to invest.
Regularly top your portfolio: Form the habit of adding to your asset regularly — say monthly or yearly. If you have the habit of saving, you will always have money to add to your asset base.
Can You Get Rich by Trading the Stock Market?
Another alternative to investing is to trade stocks. Trading requires a lot of time and is very psychologically demanding. When investing you may refrain from looking too often at your positions, but when trading, you need to monitor them daily since you enter and exit positions more frequently. So, can you get rich by trading the stock market?
Yes, you can get rich by trading the stock market. However, depending on the type of trading it might take a lot more time than passive investing. Still, the profit potential in active trading is often much greater than in typical investing.
Here are four very common trading forms that can make you rich over time:
Swing Trading is the perfect trading form for beginners. Once you have a trading strategy and routines in place, it could take as little as 15 minutes a day. You just need to spend some time after the market closes scanning the market for buy signals, and then place your orders for the coming session.
In swing trading, you hold on to your positions for a few days up to a few weeks at most.
Daytrading is a very timeconsuming trading form that is not recommended for beginners. In short, daytrading means that you close all positions before the end of the trading session.
Daytrading, like all other forms of trading, is becoming increasingly harder since there is more competition in the markets.
Position trading is when you hold your positions for a longer time, from a few weeks to a few months, in hopes of catching the larger swings in the market. In that sense, position trading could be said to be swing trading with a longer holding period!
Algorithmic trading is a trading form where you define your entry and exits criteria in a trading strategy, which is then executed by a computer.
With algorithmic trading, you could do swing trading, day trading, and position trading simultaneously. The type of trading you do is completely dependant on your trading strategy, and with the help of the computer, you can easily trade dozens of strategies simultaneously! This makes algorithmic superior to many other trading forms since it enables you to spread your risks trading many markets and trading styles!
Which Should You Choose?
For beginners, we definitely recommend starting with swing trading to see if trading is for you. Then, when you feel comfortable, you may step up your game by going over to algorithmic trading.
Many people have gotten wealthy through the stock market. You too can become rich investing in stocks if you can do what is necessary. Time is a key factor in wealth building, so you need to start early.
Trading is another way of becoming rich in the stock market.
Regardless of what you choose, it is time to get to work!