The stock market is a confusing place. People can get very rich in the stock market, but it is much more common for very rich people to lose a lot while investing. Granted, many of these these people are using some exotic instruments, and borrowing up to 25x the money they actually invest, but for the everyday person the risk in the stock market is something to be aware of.
However, staying away from the stock market is almost as stupid as ignoring the risk is you want to grow your wealth. So, is there a way to invest that won’t end in you losing your life savings in one day? The answer, is yes, but with a caveat.
Risk is something to always be aware of. Always invest with this in mind. However, the overall stock market is relatively stable over time, and over the last hundred years, it has returned on average about 7%. That means, even through the crashes that have happened, the stock market has grown at about 7% a year for the last one hundred years.
Now, a guy called Jack Bogle invented a way for people to invest in the market, with very little cost. This is what is called an Exchange Traded Fund or ETF. What the exchange traded fund does is buy, on your behalf, a large collection of stocks that is designed to track the stock market.
Because the stock market is so big, it is difficult to accurately track it. So what we do is make what we call indices. These are collections of stocks that are a good approximation of the market as a whole. The S&P500 is one of these indices. It includes the 500 biggest companies in America and is widely regarded as the best approximation of the American stocks markets’ performance.
Several companies (such as Vanguard) offer ETFs that buy into the S&P500. This allows your stock market returns to be the same as the S&P500, without having to go to the trouble (and expense) of buying 500 stocks. By owning an ETF that tracks the S&P500, you are well diversified and will get, over the long term, a return of about 7% a year. This is much better than your regular savings account.
Now, I will address the issue of how to handle the risk of the market going up and down in a subsequent post, because that is a topic all in itself. However, if you are interested in learning more about investing, or exchange traded funds, then the following books will be a great starting point. They will help you get your finances in order, and to know where to start in the stock market.