The stock market is a money-making machine. There are many ways to make money in the stock market, and each investor has to find his or her own way. What works for one investor may not work for another, because each individual investor has a unique set of financial resources, investing goals, risk preferences, and time frame.
Let’s begin with the most basic strategy for making money in the stock market – the Buy and Hold strategy.
There are many books, articles, and academic studies that support the idea that the best way for most investors to make money in the stock market is to build a diversified portfolio of stocks and bonds, and then sit back and wait for the market to do what it has always done – increase in value over the long term.
Proponents of this buy and hold strategy include some of the most prestigious luminaries in finance, including Jack Bogle (the founder of Vanguard Funds), Harry Markowitz (the inventor of Modern Portfolio Theory), and Warren Buffett, widely regarded as the greatest investor of all time. What these and many other experts in finance and investing understand is that most investors who try to “beat the market” by trying to pick winning stocks or timing when to be in and when to be out of the market, will lose. Therefore it’s better to buy and hold a diversified portfolio and not change it except to add more money during their working years.
But there are those who disagree with the buy and hold strategy, claiming that investors can do better than simply matching the market return. This strategy is called active investing, and it has many proponents who write about how to make money in the stock market.
The problems with active management are several. First, the costs involved are higher than they are for passive investing. Every time you make a trade, there is a cost. Second, it is extremely difficult for an amateur investor to know which stocks will go up faster than the market, and history has shown that the vast majority of investors who attempt to do this will fail over time.
Third, there are negative tax consequences for active trading. A buy and hold investor will only have to pay taxes when he or she is ready to retire and starts to sell off holdings to generate income. In retirement, tax rates are usually lower than they are during an investor’s working years. Active traders, on the other hand, pay taxes on short term capital gains because they are trading in and out of positions frequently.
One of the best ways for investors to make money in the stock market is by combining the virtues of these two radically different strategies. This creates a hybrid strategy whereby the bulk of the investor’s assets are held in a low-cost, diversified portfolio that will remain untouched until retirement. A second part of this hybrid strategy is to actively manage a small portion of the investor’s assets. The typical recommendation for this strategy is 80% passive and 20% active.
By combining both active and passive strategies into a hybrid strategy, investors can make money in the stock market consistently, with moderate risk, low taxes, and low trading costs.
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