How to Make Money in Stocks

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The stock market’s average return is a cool 10% annually — better than you can find in a bank account or bonds. So why do so many people fail to earn that 10%, despite investing in the stock market? Fear and greed.

The key to making money investing in stocks is remaining in the stock market; your length of “time in the market” is the best predictor of your total performance. It’s critical to understand how your emotions can fool you into moving in and out of the stock market at the worst possible times, missing out on that annual return.

If that’s not convincing, consider this. Over the 15 years through 2017, the market returned 9.9% annually to those who remained fully invested, according to Putnam Investments. However:

• If you missed just the 10 best days in that period, your annual return dropped to 5%.
• If you missed the 20 best days, your annual return dropped to 2%.
• If you missed the 30 best days, you actually lost money (-0.4% annually).

To avoid both of these extremes, investors have to understand the typical lies they tell themselves. Here are three of the biggest:

1. ‘I’ll wait until the stock market is safe to invest.’

This excuse is used by investors after stocks have declined, when they’re too afraid to buy into the market. Maybe stocks have been declining a few days in a row or perhaps they’ve been on a long-term decline. But when investors say they’re waiting for it to be safe, they mean they’re waiting for prices to climb. So waiting for (the perception of) safety is just a way to end up paying higher prices, and indeed it is often merely a perception of safety that investors are paying for.

What drives this behavior: Fear is the guiding emotion, but psychologists call this more specific behavior “myopic loss aversion.” That is, investors would rather avoid a short-term loss at any cost than achieve a longer-term gain. So when you feel pain at losing money, you’re likely to do anything to stop that hurt. So you sell stocks or don’t buy even when prices are cheap.

2. ‘I’ll buy back in next week when it’s lower.’

This excuse is used by would-be buyers as they wait for the stock to drop. But as the data from Putnam Investments show, investors never know which way stocks will move on any given day, especially in the short term. A stock or market could just as easily rise as fall next week. Smart investors buy stocks when they’re cheap and hold them over time.

What drives this behavior: It could be fear or greed. The fearful investor may worry the stock is going to fall before next week and waits, while the greedy investor expects a fall but wants to try to get a much better price than today’s.

3. ‘I’m bored of this stock, so I’m selling.’

This excuse is used by investors who need excitement from their investments, like action in a casino. But smart investing is actually boring. The best investors sit on their stocks for years and years, letting them compound gains. Investing is not a quick-hit game, usually. All the gains come while you wait, not while you’re trading in and out of the market.

What drives this behavior: an investor’s desire for excitement. That desire may be fueled by the misguided notion that successful investors are trading every day to earn big gains. While some traders do successfully do this, even they are ruthlessly and rationally focused on the outcome. For them, it’s not about excitement but rather making money, so they avoid emotional decision-making.