Why do people invest in stocks? Is it because they like to take risks? What are investors looking for in return for investing in stocks? Historically, stocks yield the greatest returns over the long-run. The chart of historic stock market returns from 1986 through 2015 is shown below:
|Historical S&P 500 Index Stock Market Returns|
*Market return data from Dimensional’s Matrix Book 2016.
As you can see from the chart, the annual rates of return fluctuate from year to year. The average rate of return from the stock market from 1986 through 2015 is 11.76%. Most savings accounts today pay less than 1% interest annually. Can you see why people might be interested in investing in the stock market? One benefit of investing in stocks is the possibility of earning a higher rate of return than those of savings accounts. Another benefit of investing in stocks is the steady stream of dividend income which can offset the price changes.
If you take a look at the information in the chart, you will notice there were years with extremely high rates of return and years with extremely low or negative rates of return. The trouble with investing in stocks is knowing exactly when to buy and when to sell. These are some of the risks of investing in stocks.
What comes in to play that causes stock prices to fluctuate? Often, investors’ emotions play a key role in stock prices. If an investor becomes anxious about the price of the stock dropping, that person may sell the stock at the point when the price is trending down which causes a risk for the investor. Instead of selling the stock based on emotion, the investor might be better off holding on to the stock until the price settles down. However, what if the stock price does not rebound? Then it might be the right time to sell before further losses are incurred. Economic and political conditions can also cause stock prices to change as well as defective products or other company issues.
An investor that is investing for the long term will not be as affected by price changes as much as a short-term investor might be affected. Those it in for the long haul realize there will be times of growth and decline and have chosen to ride out the changes. As I mentioned in a previous article, diversifying your portfolio can help alleviate some of the risks of investing in stocks alone. A portfolio with a mix of stocks, bonds, and mutual funds would be advisable.
One good learning tool for investing in stocks is How the Market Works virtual stock market game at http://www.howthemarketworks.com/. In the past, my students have played this game and have learned a great deal about how to invest in the stock market. If you are interested in practicing your investing skills, register for free and sign up for a contest. You might be surprised at how much you can learn about the Market!