Finance Friday returns with a piece on using the stock market. As someone who’s made a bit of money investing opportunistically over the years with the money I can afford to lose, I found this piece fascinating. People will often talk about index funds but I’d never had anyone sit down and explain how to invest in one.

There’s a reason to invest in the stock market that gets mentioned in this piece, but not delved into in great depth: if one believes in a company, investing is also a way to fund them. Countries with weaker stock markets have companies that have less funding; America’s strong stock market is also evidence of its robust economy. When you think about it that way, making money through Ford, or General Dynamics, or any of the other companies that hire American workers to produce things one can hold in one’s hand is simply being repaid for an investment not only in a market that’s likely to make you money, but also into American institutions responsible for keeping that money safe and secure.

THE BIG STORY

Why You Should Invest in the Stock Market

A primer on how to make savings grow using the stock market as an investment vehicle

In the past we have written about creating a budget and putting money aside in your Thrift Savings Plan (or TSP) account to let it grow. But why is TSP the best option to save for retirement? Isn’t everyone upset with Wall Street — why should I trust them with my money? The answer to these questions, while nuanced, is pretty straightforward: investing now will give you greater ability and flexibility at a future time. Owning diversified, low-fee stock funds is the most dependable way to build a flexible financial future.

The compound interest you get from investing in a low cost index fund is the most powerful tool to grow your savings. This compound interest calculator shows the profound impact it can have. For example, let’s say I have 35 years until I want to retire. I currently have $100,000 in my investment account, I can contribute $1,000 a month to this account, and the average return of the S&P 500 during 1957 - 2022, is 10%. Plug that all into the calculator and after 35 years I have $6 million in the bank. Sounds like a pretty nice retirement! This tool does not account for other costs such as taxes or fees of the index fund, but these funds are made to have low fees - around 0.04% or 40 cents annually for every $1,000 you have invested. While this isn’t an exact example, hopefully you see how powerful compound interest can be when you are consistently investing over a long time period.

Without getting too far into the mechanics, let me share a little background on the stock market. The New York Stock Exchange (NYSE) is the largest of several stock exchanges around the world, and dates back to 1792. The NYSE lists publicly traded companies and facilitates trades between buyers and sellers of those companies’ shares, enabling you to invest. Professional traders, individuals, and pension managers (to name a few) all buy and sell shares of publicly traded companies. Companies become listed on the NYSE through a process called an Initial Public Offering (or IPO). When a company holds an IPO, investors purchase shares in the company and that money goes into the bank account of the newly “publicly listed” company. This explanation is simplified but you get the point. The company can then use this money to grow, and that is what you are truly investing in: a company's ability to use your (and others) money to grow so that the stock is valued higher than when you bought it.

Now let’s zoom back out. The most boiled down goal of investing is to buy low and sell high, and you might be able to pick stocks that will increase in value. I’m not saying you aren’t right, but remember there are people out there who have spent their entire professional lives studying, analyzing and testing their stock picking strategies. This is where diversification comes into play. By purchasing a range of stocks you can lower your risk, basically you are not putting all your eggs in one basket. Low cost index funds are a fantastic option when investing in stocks. In fact, legendary investor Warren Buffett once bet that an Index Fund tracking the S&P 500, a group of stocks of the 500 largest companies in the United States would beat the performance of five hedge funds (where those professionals I was talking about who eat, sleep and breathe stocks work). Over the 10 years of the bet, the hedge funds returned 36.3%, while the S&P 500 returned 125.8%.

One variable that makes actively trading stocks challenging is capital gains tax. Short term gains, or those from stocks held for less than one year, are taxed at a higher rate than gains from stocks held for over one year. This is an important consideration, and another reason to buy and hold low cost index funds - the American economy will continue to grow and so will your investments. Check out this article for more information on starting your investment journey.

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HUMOR

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