Have you been wondering how much money can you make in the stock market? Today I will walk you through all the different scenarios.
Let’s start by explaining what is the stock market and how it works.
What Is The Stock Market
When a company needs capital they have two options. One is taking out a loan and the other one is getting money by issuing shares. There is a difference between those two – taking out a loan is tied to some fixed return for the bond holder. Issuing shares doesn’t have any set returns for the share holder.
The share holder get a part of the company in return for taking on more risk. After all in the event of default the bond holders have the priority over the share holders.
So the bond holders have a set return over a period of time. For example if they agree on a 10 year loan on 5% interest that means they will be getting 5% on their money as interest every year on top of the principle.
Share holders on the other hand get more risk, which of course comes with a bigger upside potential. As a part owner of the company you are directly benefitting if the company grows and expands. The company gets bigger, which means that your shares are worth more, because the market capitalisation increases.
Of course that goes both ways – if the company is struggling, their market cap decreases and in return your shares are worth less. All of this variability makes people wonder how much money can you actually make. And my short answer is that it can vary a lot between people.
There are people that make fortunes in the stock market, while there are also people that lose everything they have rather quickly. Let’s start by seeing what is the average return of the stock market.
Market Average Return
You can see the historical graph of the Dow Jones Industrial Average (DJIA). This is one of the oldest indeces in the world and gives us a good idea of how the market has been performing.
It is kind of hard to measure the returns reliably all the way back to the 19th century. But as a rule of thumb the markets return around 7% on average in a long-term timescale. Of course, past returns do not guarantee future performance. But this is the most reliable data we have as of today, so it is a good benchmark.
What that means is that if you invest in a index fund(LINK) that tracks the DJIA or the S&P500, you can reasonably expect around 8% returns adjusted for inflation. Of course that is given the fact that you leave your money there for long enough period of time.
If you look at the graph you can see a nice, steady uptick to the far right. But if you look closer you can see many periods, where the market has been on break-even point for even decades. For example between the 30’s and the 50’s you would have been break-even on your invested money if you held during that time. But that is a risk that every investor should be aware of.
So in short – if you leave your money in an index fund and just let it compound for a couple of decades you can reasonably expect around 8% annual rate of return. But let’s take a look at a couple of examples who utilised the markets to a better extent.
Examples
Berkshire Hathaway
Berkshire Hathaway is a holding company founded by Warren Buffett(LINK). They have managed to achieve around 20% average annual return since their inception in 1965. Let’s take a look at how does that look in a graph.
As you can see the difference is staggering. That little blue line at the bottom is the Dow Jones Industrial Average. And here is the interesting part – the Dow Jones has actually performed quite well during this time. But Berkshire’s performance makes it look like it has barely moved.
Put let’s put this in some real world perspective. According the this article $1,000 invested in the S&P500 would be worth around $200,000 today. And honestly that is a very decent return.
But the same $1,000 invested in Berkshire Hathaway would be worth $27 million today. Goes to show what a difference compound interest can make.
Before we continue, please be advised that this performance is a huge outlier and we are hardly going to see anything like this again. Berkshire’s performance has benefitted from a lot of tailwinds and have used them to their best ability. It will be very hard for anyone else to replicate the same performance going forward.
The Magellan Fund
The Magellan Fund was operated by Peter Lynch between 1977 and 1990. It is up to this date the best-performing fund in history with almost 30% average annual return. Here is a graph to show you how that looks like.
In other words $1,000 invested in the Magellan Fund in 1977 would have been worth around $28,000 in 1990.
Mutual Funds Performance
According to an article from CNBC 91.6% of mutual funds have underperformed the S&P500 over a period of 15 years.
Or in other words – just by investing in an ETF you would have performed better than 91.6% of mutual funds. Which sounds funny, but it’s true. Just by investing in a simple index fund you would perform better than the overwhelming majority of fund managers.
But of course, there are a lot of things at play here. First mutual funds have to play with the inflows of their customers. And people tend to invest money when times are good and withdraw money when times are bad. To be successful you want to essentially do the opposite. But mutual funds have trouble doing it as their inflows and outflows are forcing them to sell low and buy high.
What you can see here is that the biggest surge in money into mutual funds was in 2007, followed by 2019 and 2000/01. Very closely after followed the dot com crash, the financial crisis and the recent crash in 2020.
You can also notice that during those crashes we had the biggest outflows from funds. Usually that’s the time when you want to invest money rather than withdraw it. Of course, people are sometimes forced to sell their assets during crises, that’s normal. Just wanted to show you how this can be a disadvantage and lead to underperforming the market.
Another thing that comes into play is their fees. Most mutual funds have managing fees of over 1%, which absolutely destroys any advantage they might have.
But no matter the causations, it’s interesting to know that the big majority of mutual funds actually underperform the market. So if you invest in mutual funds there is a big chance you will see below those 8% of long-term returns.
For everyone interested in how Warren Buffett or Peter Lynch achieved those returns, you can check out the books section. There you can find my favourite books from both of them, where they explain in detail their investing approaches.
Retail Example
To help you understand things a bit better let’s take a look at one example. Let’s say you have $500 that you would like to invest in the stock market every month. Let’s see how would that work assuming 8% rate of return.
As you can see in 40 years you will have total assets of more than $1,7 million. Another thing worth noticing is also how those returns start compounding over time. For example in the first 20 years you would make less than $300,000. But then in the next 20 you would make almost $1,500,000. Which brings me to the next point, which is what it takes to make those returns.
How to make money in the stock market
If you have seen movies or watched financial channels you would think that making money in the stock market requires a super sharp mind or extensive financial knowledge. While those two certainly help, they are not exactly the main component for the recipe. Being successful in the stock market boils down to three things – strategy, patience and mindset.
Strategy
Here you can pick one according to your personal preference and there are no wrong answers. To see the main strategies click here(LINK). As I said the important part here is actually following your strategy and not being all over the place.
A recipe for disaster is being chaotic and switching strategies all the time and jumping in and out of different plans. That’s why my advice to you is take some time and think your plan through. Decide on a strategy, think about what your portfolio(LINK) would look like and maybe create a watchlist(LINK).
Once you do that, then you can start slowly adding stocks/ETFs to your portfolio. Remember – investing is a long-term game, so don’t rush. You have plenty of time and there is no point in rushing in and out of stocks before you have a proper strategy.
Patience
You have your strategy, time to add some patience to the mix. And honestly this is easier said than done for beginner investors. Everyone is tempted to play around with their portfolio once they start out. And that is honestly normal – you will most probably make that mistake as well. But be sure to understand it and try to learn from it.
With time you will get more composure and daily movements in the stock market would not bother you much. I am saying this, because at the beginning you will see the stock market going up and down as well as your portfolio. You will see news and people talking all kinds of different things. And that could make you become impatient and start buying and selling, which is in most cases a mistake.
But there are good news – usually with time you will get more “blunt” on all those news and movements. My rule of thumb is that the less I check the markets and different social media channels the better. What I need is just major finance news and earnings reports, and maybe some quality analysis here and there.
All the rest is mostly noise that you don’t really need. It is easy to get hooked into different groups and channels that promote stocks on a daily basis. My advice is to stay away from those, because more often than not you will get information that is not beneficial to you or your portfolio.
Emotions
What I mean by mindset is keeping your emotions in tact. There are two big enemies to investors – greed and fear. Greed causes mistakes when buying stocks, while fear makes you panic and make mistakes mostly when selling stocks. Or in other words – those emotions make you buy high and sell low. If you want to make returns you want to actually do the opposite.
Of course that is easier said than done, especially when you are starting out. A lot of investors have done those mistakes, I have done those mistakes and you will probably do those mistakes. And again the important part is to learn from them. You will strengthen your mindset with experience and composure.
That’s why my advice here for you is to start with a small sum of money and gradually invest more as you get more experience. This way you get to learn first-hand and start slowly building your portfolio.
How can you start in the stock market
Ok, you now have a strategy, a watchlist and you want to get into building your own portfolio. My advice to you is use a zero commission and beginner-friendly stock broker. For all of you in the US you can get started with M1 Finance. Those of you in the UK Freetrade is a very good choice.
Both platforms are very user-friendly and a good choice to start building your portfolio.
Summary
As you can see you can indeed make money from the stock market. But you have to avoid some common mistakes and build your portfolio with some thought on the future. There is a common theme amongst every successful investor.
It takes everyone some time before seeing some solid returns. It’s because investing is not a get rich quick scheme, but rather a mindful, long-term approach.
Thank you all for reading, hope you had a good read. If you found the article interesting don’t forget to join the newsletter and also receive a free eBook on how to build a monthly portfolio.