WHY SHOULD I INVEST IN THE STOCK MARKET?

Why would someone invest in the stock market? This is an excellent question, and the answer is to get your money working for you. There are a couple of very important ways that you make money with owning common shares. First is the potential for a capital gain if the shares go up and you sell them for a profit. Second, is the possibility that the company will pay out a dividend to its shareholders. Companies can share their profits with their owners, and many senior companies do that every quarter or sometimes monthly. They announce the amount and payment date of their dividend payout in advance, which brings us to the topic of “yield.”

Yield is the amount of money you earn each year by owning the stock of a company. We always express a dividend in terms of dollars and cents per share. You can easily calculate your “yield” as a percentage using the dividend amount and the price you paid for the stock. Please remember that a company can raise or lower the dividend amount as financial conditions change for them. Your yield is determined by the price you paid, not what the stock is currently trading for on the market. Let’s look at our company Orange and see how this works. We assume you bought the stock initially for 10.00 per share and let’s pretend that the company announces a dividend of .50 per share annually. It doesn’t take a lot of math to figure out that the “yield or earning” on your shares is 5%. If someone else bought the stock on the market for a higher price, then naturally their yield would be less.

Let’s return to the opening line of this article- “why would someone invest in the stock market?” We will introduce something here that may be of interest–the Rule of 72. Many people do not want to take the time and effort to learn a few basic investment procedures and tell others it is too complicated or too risky, etc. Let’s add some reality to that argument. Suppose that someone has $10,000.00 available to put away for retirement and they are only comfortable putting it into a savings account at their financial institution. What is the current rate for savings accounts? At the time of writing, it is around 1%. The Rule of 72 states that if you divide 72 by the rate of return (in this case, 1%) the result is the number of years it will take to double your initial investment. SARCASM ALERT: For the safety conscious non-risker takers, add 72 to your current age and you will have turned your $10,000.00 into $20,000.00. Fantastic! You have doubled your money. By the way, we have not considered the ravages of inflation or taxes, but in only 72 years you will have twice as much money assuming you withdraw nothing during that time.

Let’s go back to our example of Orange in which we determined that if you bought the stock at 10.00 and receive a .50 dividend each year for a return of 5% how would we fare with the Rule of 72? We divide 72 by 5 and learn that if we do not withdraw any of the earnings, our money will double in 14.4 years. You can do the calculations yourself for different scenarios. That alone is reason to give serious consideration to investing in stocks. This process also works if you only consider the growth in the stock market itself if you own the right investments. We will cover some of those types of investments later but consider this: The 25-year average annualized return for the S&P 500 from 1994 through 2018 was 8.52%. If you had invested in an index fund that tracks the S&P 500 in 1994 and you never withdrew the money, you would have average returns of 8.52% per year. At that rate, expect to double your money about every 8.45 years. For those people who already follow the market a bit–this includes the fact that it had many swings in value both up and down during that period.

OK, enough math for today–your head hurts and this was precisely the stuff you wanted to avoid – right? Common stocks are not the only investment available on the market, and we have already alluded to at least one other. We will move on to some of these possibilities next time.

If this is your first exposure to this series, you might find it helpful to start at the beginning with our bite-sized lessons about investing and the stock market. You can also share this with friends and on any social media platforms if you want to.