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The stock market is one of the best places to build long-term wealth. It’s one of the most passive forms of investment, yet it has returned investors an average of 10% over the last 100 years of its existence.
I haven’t been investing actively for long, but as I look back on a graph of my investment contributions and the corresponding returns, I’ve seen this truth play out. After only a few short years, I’ve begun to see the power of compounding interest at work in my investment accounts.
Contrary to what your brother-in-law might tell you, growing wealth in stocks isn’t often achieved by following “hot tips” or day trading. Consistent and patient people who commit to investing in their own futures day after day, year after year, are the ones who come away with long-term wealth.
If you’re at the beginning of your wealth-building journey, you’ve found a good place to start. In this article, we’ll help you determine your investing parameters, introduce you to the best places to keep your stocks and give you some helpful tips on what to do (and NOT to do) if you want to build long-term wealth in the stock market.
You wouldn’t start a road trip without a destination or a map. Why would your path to wealth be any different?
Before you go throwing money into stocks, take time to assess your goals and how your investments will get you to them.
I have two main goals for my investments.
- Grow long-term wealth through mutual funds, ETFs, and stocks in my retirement accounts
- Increase earnings on my discretionary savings (i.e., saved money that’s not part of my emergency fund)
I have different accounts to hold a different collection of assets for each of these goals. (More details on that below.)
Why are you trying to build wealth?
Are you saving for a down payment on a house? Are you looking to fund your child’s college education? Are you investing for retirement?
Your motivation for investing will be key in determining not only what stocks you buy but also what kind of account you keep your money in.
Not all accounts are created equal. Even If you own the same stock in brokerage, retirement, and 529 accounts, the money you make from it can be very different based on taxes, penalties, and fees. (More on account types below.)
For instance, I keep my retirement savings exclusively in IRAs and Roth accounts to reap the tax advantages. I know I can’t take the money out without penalty any time soon, so I am not tempted to do so.
I’m also socking away cash for a trip to Italy. Given the current state of the world, I don’t need that money very soon, but I do need it to be liquid enough to buy a plane ticket when Italy opens back up. So I keep my “Italy Fund” in a brokerage account where I can get to it easily.
When considering your time horizon, there’s only one question to answer: How soon do you need to take the money out?
A nearer time horizon may shorten the list of stocks and investments that are right for you since you won’t be able to tolerate dips in the market without the risk of losing your initial investment.
The longer you can stand to keep your money in your investments, the more risk you can tolerate—and the more potential for the reward you stand to gain.
But if you only have even five or ten years to work with, your cash will probably return more if it’s in stocks than if it’s in a savings account or under a mattress due to stocks’ higher rate of interest. Cash will lose value to inflation, which is about -3% per year. This means that if you stick $200 under your mattress in 2021, that will only buy you $167 worth of stuff in 2031 because your money is worth less.
Even in a savings account, you’ll have less buying power in 10 years as savings accounts these days are lucky to give you even 1% in interest. You’ll only lose 2% annually, but you’re still losing out by not investing.
Compound interest is powerful. If wealth is your goal, you’ll need this tool on your side—it’s simply impossible to penny-pinch your way to lasting wealth. Over time, your invested money will work harder for you than you ever can for it.
For this reason, an investor that contributes $200 a month to her retirement account at age 20 will have $1.1 million (assuming a 10% return) when she retires at 60. If she waited to start until she was 30, she’d need to contribute $540 per month to get a similar nest egg.
The curve for the benefit of compound interest isn’t linear—it’s parabolic. The curve at the end of the timeline is MUCH steeper than it is at the beginning; the majority of the gains your investments earn come at the END of your time horizon. Give your investments the best chance at long-term growth by starting early.
Types of Accounts and their Benefits
With the questions of your goals and time horizon answered, choosing an account to buy your stocks in is relatively easy. Here’s a rundown of some of the different types of accounts for long-term stock investing, and the benefits of each.
A 529 account has definite limits in that contributions can only be withdrawn without penalty if they’re used for educational purposes (tuition, books, fees, etc.). But if you’re saving up for a college education (for your child, grandchild, or even yourself) and you have a long time before you need the cash, a 529 account is a good way to go.
Unfortunately, you can’t pick the individual stocks in this account; you select from preset portfolios based on your time horizon and risk tolerance.
Your contributions enjoy tax-free growth, and many states will credit a certain amount of your contributions toward your state income tax. Each state offers its own plans, but you don’t necessarily have to reside in the same state that your plan originates from, nor does your child have to attend school in that state to use the funds.
Each 529 account can only have one beneficiary, so if you have multiple children, you’ll need multiple accounts. However, if one child doesn’t need the funds or chooses not to pursue an education, you can transfer the account to a different beneficiary.
Be advised, however, that if you withdraw the funds from your 529 plans for anything other than educational expenses (books, tuition, fees, etc.), you’ll not only owe federal income taxes but a 10% penalty as well. Your retirement and other savings belong in other types of accounts.
One of the most common retirement accounts, 401ks are offered by employers and often come with a match—which is free money! If at all possible, contribute enough to your 410k to get the employer match.
Aside from an employer match, the biggest perk of the 401k is that your contributions reduce your taxable income—freeing up more of your money to invest!
You only pay taxes when you withdraw the money during retirement. Withdraw any earlier and you could be subject to federal taxes on the money and a 10% early withdrawal fee.
This retirement fund offers no tax deductions on the front end, but all the gains your investments earn can be withdrawn tax-free during retirement. If you meet the income requirements for a Roth account, it’s one of the best ways to shelter your wealth from taxes.
After contributing enough to get my husband’s company match, we put all our retirement savings in Roth accounts before using IRAs, since the growth of our investments is tax-free.
As another perk, you can withdraw your original investments (NOT the gains) at any time without penalty. So if you’re saving for a down payment on a house and want to park the cash for a year or two, a Roth is a good place to do it.
Like a 401k, a traditional IRA reduces your taxable income, but your yearly contributions are much more limited ($6,000 vs. $19,500 in a 401k). Distributions during retirement are taxed as income.
However, traditional IRAs often offer a broader diversity of stocks, ETFs, and mutual funds to choose from. If your employer offers a match, fund a 401k first. If not, use a traditional IRA to grow your retirement nest egg.
These accounts have no tax benefit, so they should only be used if you need quicker access to the cash than a retirement or 529 account. You’ll pay capital gains taxes on the gains from selling stocks at a profit, as well as some dividends you receive.
But even here, long-term investors get a break, as stocks you hold for a year or more get more favorable treatment at tax time than short-term holdings.
How much capital gains tax you pay is dependent on state and federal laws, the type of asset you own, how long you’ve owned it, your tax bracket, and more. For instance, certain states and even cities (like NYC) will charge federal gains taxes, even if you’re federally exempt due to your income level. Understand the tax info in your area before you cash out your stocks so you’ll be able to make a good decision on whether and when to sell.
Even with the ding of taxes, a brokerage account can make sense for certain situations. For instance, say my $1,000 Italy Fund earns 10% interest in a year. Even if I have to pay the highest capital gains tax bracket (37%), I’ll still come away with $63—much more than my Italy Fund would earn languishing in a savings account.
Also, be aware of brokerages that charge trade fees or commissions on trades. With so many brokerages and stock trading apps (like Webull, Robinhood, and TD Ameritrade) offering free trades, there’s no reason to pay these fees any longer.
Now that you’ve got your money in the right type of account, you likely still have questions about what to do with your funds.
What stocks do you buy? Do you put in a big chunk of cash or buy a little at a time?
Here are a few strategies used by successful long-term investors.
Keep Costs Low
Commissions and fees can eat into your investment returns if you aren’t careful. While you should expect a small fee (i.e., less than .5%) on an index fund and an account fee or custodian fee (which covers the cost of reporting to the IRS), it’s worth knowing that fees rob you of potentially thousands of dollars in compound interest over the life of your investments.
Advisor fees are some of the heftiest you can pay for investing. The average advisory fee is about 1% of assets under management for an account of $1 million. So just for having an advisor (even if he or she doesn’t make you any money at all), you’re losing $10,000 in investment power each year.
If you do decide to go with an advisor, using one with a fee-only pay structure rather than a commission-based one can help you save money. Ensure the returns you are getting are worth the price you’re paying for the management.
To avoid advisory fees and maximize your long-term gains, choose a variety of index funds or ETFs with low fees (less than .5% is pretty good). When I started investing, I put my money in my employer’s target-date funds, since I had no idea what I was doing. Back then, I didn’t realize I was too heavily weighted in bonds for my age (mid-20s). I was also paying more administrative fees for my funds than I needed to, which further eroded my puny returns.
I’ve done much more research on investing since then. Now, I choose my own mutual funds and ETFs. My favorite mutual fund (VTSAX) has a very low fee of .03%. My favorite growth ETFs (ARKK and ARKW) have higher ones (.75% and .76% respectively), but the higher rate of return on these ETFs more than justifies the additional fees.
Stocks go up and down by the minute, so how do you make sure you’re getting the best deal when you buy? Ironically, it’s when you stop trying.
By investing a set amount each week or month regardless of market conditions, you end up paying less for your investments than if you try to time the market, only buying when stocks are low.
This is because your money goes further when stocks are cheaper; you’ll end up buying more shares when the market is down. You also don’t miss out on the growth your investments see with additional time in the market.
Over time, the highs and lows matter less and less. By sheer luck, my husband and I rolled over an IRA and bought a ton of ETF shares for cheap during the pandemic market crash in March 2020. We’ve also missed out on huge stock gains, thinking “We’ll wait and buy the dip,” only to see the stock ride even higher before we bought. In the end, neither has amounted to the magnitude of gain or loss that we originally predicted. The true gains we’ve seen have come incrementally as we contribute to our investments month after month.
If you do receive a windfall you want to invest, consider spreading out your stock purchases over a few weeks or months to smooth out the ups and downs in price.
Investing consistently and letting dollar-cost averaging and compound interest work their magic is the best recipe for building wealth over time.
Knowing your current financial situation and making educated predictions about your future can help you plan your investments to minimize your tax burden and maximize your returns.
The first play in tax optimization is to take advantage of account-specific tax benefits, like the tax reduction power of an IRA or tax-free growth in a Roth or 529 account.
The money in taxable brokerage accounts is subject to capital gains taxes, so it’s best to only put money in that you need to be somewhat easy to get out again.
Once COVID-19 hit, I put my vacation savings in my Webull account. Even though I know I’m paying capital gains tax on my earnings, it’s better than what I’d get in my savings account, and I can keep my cash fairly liquid so when Italy reopens to tourists, I’ll be ready.
A Word on Day Trading
When people think of stock investing, it generally conjures up images of people scrutinizing complex charts and graphs, making lots of trades, and split-second timing. This is the world of day trading, where people buy and sell stocks within 24 hours. (Swing trading is similar, where you hold stocks for days or weeks before exiting the trade.)
However, day trading is decidedly different from a buy-and-hold investing strategy or even occasionally trading stocks on a phone app like Webull. day trading requires a minimum of $25,000 to start, as well as access to and understanding of complex analytical software. It also involves considerable risk—much more than buying and holding a diversified portfolio of stocks.
But perhaps the biggest differentiator between day trading and long-term investing is the time involved. Serious day trading involves many hours a day, so it’s more like a full-time job than a hobby or even an investment strategy.
While day trading certainly seems sexier than holding a variety of well-chosen stock positions or a few index funds, the sad truth is that the statistics favor the long-term investor. As many as 7 out of 10 day traders lose money and most day traders quit within the first two years. While it’s possible to make money doing both, long-term investing is an easier, surer, more efficient way to do it than day trading.
Dos and Don’ts of Long-Term Investing
If you’re new to investing, all the jargon, charts, risks, and ticker symbols can quickly get overwhelming. While it’s not comprehensive, this list will give you a few pointers on what to do and common pitfalls to avoid when investing in stocks for long-term wealth.
- Align your account type with your goals/time horizon. You’ll miss out on tax savings if you just dump all your money into a brokerage account. Where you put your money is almost as important as what you invest in.
- Look for ways to minimize your taxes. This shouldn’t be your primary driver; you’re in stocks for the returns, after all. Still, being mindful of how your gains will be taxed opens up opportunities for you to save money.
- Invest often. Most long-term investors make a set contribution each month, then let dollar-cost averaging level out the daily peaks and valleys in stock price. Maximize the time your money has in the market by buying assets month after month, regardless of market conditions.
- If you find a winner, stick with it. After my TSLA stock hit $400 a share, I was elated. I wanted to cash out and claim my prize! As it’s trading at over $600 a share at the time of this writing, I’m glad I resisted the urge to sell. Of the 26,000 stocks, only 1,000 produced all of the profit in the stock market since 1926, so hold onto your winners if you find them.
- Diversify. Concentrating a large portion of your investment in one stock or sector exposes you to increased risk. Be sure your portfolio has the appropriate amount of diversity for your time horizon.
- Invest in what you understand. Don’t buy crypto just because it’s all the rage. Invest in industries you’re familiar with, particularly ones where you might have more inside knowledge than the average investor. If you can’t explain the investment to a friend, give it a pass.
- Start early. Even if you don’t have much to invest and you’re not sure where to start, your future self will thank you for getting started. The more time your money has to grow, the bigger it can get. If you only have a few dollars to get started, download an app like Webull or Robinhood to put your pennies to work.
- Start investing before your house is in order. If you’re up to your eyeballs in debt, you have no business investing (with the possible exception of retirement contributions). Make sure your financial affairs are in order with adequate savings, insurance, and minimal debt before you focus on investing, as any wins you make in the stock market could be wiped out by financial failings in other areas.
- Make emotional trades. Check your emotions at the door when trading stocks. FOMO on high-riding stocks and fear of losing your investment will tempt you to buy high, sell low, and lose money.
- Trade often. Resist the urge to buy and sell often, which opens you up to too much emotional influence. Buy sound stocks with growth potential and reassess your portfolio every six months or so (I do this on Memorial Day and Veteran’s Day). Give it time and let your little nest egg incubate.
- Try to time the market. This means timing your trades so you always buy low and sell high. Many times, I’ve held out, thinking “I’ll wait and buy this stock when it dips.” Just as many times I’ve missed out on growth because the stock continued its upward trend instead of dropping. Unless you have a magic crystal ball, don’t worry too much about market timing; dollar-cost averaging is the way to go.
- Delay starting. “I’ll start investing after I get that promotion, after I buy a house, or after I’m making more money.” Excuses like these are stealing precious time from your would-be investment returns to compound. Unless you’re in a precarious financial situation, there’s no better time to start investing than today.
- Hold onto losers. Don’t forget that stocks can and do go all the way to zero. Like the produce clearance section at the grocery store, stocks usually hit rock-bottom prices for a reason. If you’re holding onto a losing stock, cut your losses and move on.
- Avoid the temptation to get rich quick. My favorite quote about investing is “The bulls and the bears get fed, but the pigs get slaughtered.” An overeagerness to see sky-high returns overnight is a recipe for disaster and disappointment. Excessive greed can lead you to take on too much risk. Remember, you’re in this for the long haul; wealth takes time to build.
- Skip the research. Picking individual stocks takes knowledge and skills. If you’re not willing to put in the time and energy to research individual stocks, you’re better off sticking to passive ETFs and index funds.
- Be afraid to use mutual funds or ETFs. Many people don’t have the time or inclination to invest in individual stocks. There’s no shame in that. In fact, ETFs and mutual funds are specially designed for passive investors who want a more hands-off investing strategy but still reap a healthy return.
The hardest thing about long-term investing has nothing to do with charts, brokers or reading a prospectus. Maintaining your persistence to keep contributing to your investments and your patience as you watch them ride the bumpy path to growth is much more difficult than calculating a price-to-earnings ratio.
The best long-term investors:
- Choose quality investments
- Contribute to them regularly
- Assess them periodically (not daily)
- Make changes based on their needs, not emotions
Get your house in order. Start early and have a plan. Stick to your plan through the inevitable downturns and keep your emotions out of it. Do your homework and stay in for the long haul.
Investing may not be easy—it requires patience, persistence, and discipline—but it certainly can be simple.
Contributor’s opinions are their own. Always do your own due diligence before investing.
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- Investing: Why It’s Important and Why You Need to Start Doing It