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January 2, 2006

How to Invest in the Stock Market

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Photo Credit: Karin Catt

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Whenever someone talks about “beating the market,” they always seem to focus on their short-term gain and not their long-term loss. As anyone who has ever been to a casino knows, although you can have a big win once in a while, in the long run the house always wins.

The beauty of the stock market is that you can bet on the house (the market itself) and reap the benefits of always winning in the long run. The best way to do this is by investing in the Standard & Poor’s 500 Index. The S&P 500 Index has been around since 1926 and is essentially a group of 500 different company stocks that have been chosen for their market size, liquidity, and industry grouping (as well as other reasons that only matter to mathematicians with pocket protectors). The S&P 500 is essentially a leading indicator of the U.S. equities market as a whole and is one of the most commonly used benchmarks for the overall U.S. stock market.

Since it is difficult for individual investors to buy the index (this means buying 500 different stocks), there are a number of financial products based on the S&P 500 including index funds and exchange traded funds (ETFs). Make sure to find the right one, as some of these index funds and ETF’s have high maintenance fees and other hidden costs.

By having faith and investing in the S&P 500, you are essentially having faith in the U.S. stock market and betting on its continued long-term growth. Although the economy can and will stall at various times in our lives (think back to the Dot Bomb), in the long run the U.S. stock market has grown and will continue to grow and provide you with healthy returns on your investment with little or no effort on your part.

Looking at the period between 1928 though 2006 (a period longer than most of us have been alive), the S&P 500 has had an annual average return of 10.3 percent. Although this represents a period-dependent outcome (everything depends on the starting or ending date, or from an investor's standpoint when you decided to buy and when you decided to sell), this type of return is healthy considering an investor only had to be patient and little else.

As for being patient, an investment of $15,000 in the first index mutual fund back in 1976 was worth $461,771 in 2006 with little or no effort on behalf of the investor. Part of the reason for this return is that there was no trading in and out of stocks. Daily or even weekly trades only line the pockets of your broker, who gets a commission every time you buy and sell a stock.

Although this approach to investing in the stock market might not seem as sexy as making multiple trades every day, there is nothing sexier than having a nice nest egg waiting for you to cash out and enjoy later on in life.


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