If you’re making good money, you may be just putting it in the bank and watching it pile up every month. That’s a great feeling, but it’s not the most efficient way of managing your wealth – particularly not with today’s miserable interest rates.
That’s why investing in the stock market is very appealing in the long term. It gives you the ability to grow your wealth through investing in companies which are themselves growing. As their earnings rise, so should the share price. In many cases, you’ll also get dividends coming through, which can either provide you with a little extra income or be reinvested in the stock (many companies have a DRIP scheme which reinvests your dividends automatically at low cost).
While it’s important to be realistic about the impact individual investors have – shareholder votes are dominated by institutional investors – you might also want to make a stand by investing ethically, or backing companies which promote diversity on their boards of directors. Investing directly in stocks allows you to put your money where your heart is. You might also decide to back deserving smaller businesses, though for safety’s sake micro caps shouldn’t make up more than a small percentage (say 10%) of your total portfolio.
Of course, you could also choose to invest through mutual funds, in which case stock selection is managed for you, or through ETFs, which ‘shadow’ stock market indices, and which you can trade through platforms like CMC Markets as well as through more conventional brokers. Funds and ETFs offer the same financial advantages as direct investment in shares – increasing your wealth both through dividends and through the growth of companies in which you’ve invested.
But is 2017 the right year to jump into the stock market? Several well-regarded analysts on the Street say ‘No’. US shares are trading at historically high levels compared to their earnings, despite lackluster growth prospects. If, as widely expected, interest rates continue to rise, asset prices could suffer. One or two fund managers are now predicting a major crash.
However, as an individual investor, you probably should not listen too hard to the voices of doom, and you should pick up on some of the detail of the discussion. For instance, it’s primarily high yield shares such as utilities that have been pushed to high valuations by investors such as retirees seeking income. These are the shares that will suffer most if interest rates rise more quickly than expected. At the same time, ‘cast iron’ values like consumer brands have also seen valuations puffed up by investor demand. They could fall rapidly if conditions change – that’s what happened to the ‘nifty fifty’ stocks in the 1970s bear market.
Look instead to invest in areas that no one has been queuing up to buy, like tech, biotech, natural resources or alternative energy. You’ll need to do your homework, or use funds and ETFs to buy the sectors, but your choices are more likely to withstand any market downturns better than more highly rated sectors. You might also consider looking outside the US to Europe or emerging markets, where valuations stand at lower levels and in some cases growth may be considerably faster than in the US.
You might still end up out of pocket at the end of the year. But equity investing isn’t about making money over short timescales, and if you need the money in the short term then you probably shouldn’t be buying shares. Putting money into equities – however you may finesse the ups and downs of the market – is about compounding and the time value of money; that is, reinvesting your profits and dividends and seeing the value of your reinvested money, as well as your original capital, grow over ten or twenty years, or even longer. The longer money is invested, the greater returns it will make.
Drip feeding your money into the market is one way of guarding against sudden falls in prices. Use a monthly investment scheme or simply discipline yourself to put money in your investment account every time you get paid. Monthly investing averages prices so in the event of a market fall, further investments are made at lower prices.
So, on balance, 2017 might be a tricky year for the equity market – but if you don’t already invest in equities for the long term, it’s still a great time to get started.
Image by bfishadow, freely licensed under CC-BY 2.0.