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At this point in your financial journey (being that you’re here reading this), you know that investing is one of the best ways to build wealth –– *especially* over the long term.   Unfortunately, in most personal finance advice, that’s where the conversation ends. It’s left up to you to wade through statements like “the market grows at an average of 7% each year!” or “compound interest is your best friend” or “check out the dividends!” and smile and nod along, ignoring the panicked voice in your head saying “wtf does that even mean.”

If you haven’t actually started investing yet, you may be avoiding it for a number of reasons –– fear, anxiety, feeling like you’re not financially prepared enough, or just feeling unsure where to start.

If this sounds familiar, even a little bit, this article is for you. Today, we’re going through how your money grows in the market, what to look for as you analyze your portfolio, and some basics on different ways you make money from investing.

Before we go on, this article is from Stock Market School –– an investing community that actually teaches you how to invest and provides you with education and community to help demystify the process and make investing accessible for all. Learn more about our user-friendly investing platform.

Unsure if you’re ready to start investing? Ask yourself these questions:

• Do you have an emergency fund of 3-6 months?

• Have you paid off high-interest debt (i.e., anything over 7%)?

If you’ve answered yes to both, it might be time to start investing! Even if you didn’t, read on –– education is powerful, and understanding how investing works and why it needs to be a goal to work towards is incredibly important.

There are a few ways you “make” money in the market –– here’s a quick breakdown of how.

Appreciation

Appreciation happens when you buy a stock or a fund, and the value goes up, meaning the price of the stock or fund you own has gotten higher. This is what we all wish had happened to our beanie baby collections.

If you want to lock in the gains from the stock, you have to sell to do so. Remember that there can be tax implications to selling and you may be subject to capital gains tax on the profit. The same is true for the inverse –– if a stock or fund is performing poorly, you’re not “losing money” until you sell, unless the company goes out of business. Once you sell, you’ll have cash in your account for the value of your shares at the time you sold, and your appreciation will be that value minus the price you paid.

This might leave you thinking that every time the market hits a new high, you should sell — but that is the last thing you want to do for a long-term investing strategy. Remember, the stock market sees an average annual return of 7% a year –– meaning that if you’re diversified, your stocks and funds will also see around that average amount of growth year after year. This year’s high point may be next year’s baseline and vice versa. This is why we keep our money in the market for the long haul and allow it to grow.

But how does this make you money if you don’t sell?! Great question! There are two answers –– compounding and dividends.

Compounding

Compounding is magic. Like, really. It’s pretty damn impressive when you really think about it. The idea is this –– when your money compounds, you earn money on the money you’ve earned. Let’s play with the following example:

You buy stock A for $1000, and it appreciates 7%, meaning that at the end of the year, it’s valued at $1,070.

The following year, it appreciates again at 7%, but this time, the return is compounded (meaning you make money on the money you made from the previous year), valuing this stock now at $1,144.90. In 5 years, the stock is valued at $1,402.55. Your initial investment is still only $1,000.

This starts getting pretty significant as the years go on and as you add to your portfolio. In 30 years, if you never put another penny towards that investment, your $1,000 stock appreciates to $7,612.26.

See! Magic!

Two things to keep in mind with compounding:

1. Just because your stock appreciates doesn’t mean that you should just stop investing. Compounding is awesome, but the more money you can invest, the more you’ll get out of the market in the long run.

2. It might be tempting to sell the stock at a high, but remember that when you sell, you don’t get to take advantage of the compounding on that investment anymore. Compounding does more for you the longer you wait!

What About Dividends?

Dividends are monetary or stock returns paid from companies to their shareholders. They are usually a fixed-dollar amount per share and paid out quarterly (though some companies offer stock dividends like extra shares). From the company’s perspective, if their business is doing well and they have more money than they want to invest in growth, they can give that money to their shareholders as a dividend. Some investors like dividends because it allows them to make income from their investments.

When you receive a dividend, you have a choice of either having your brokerage receive it as cash (which will sit in your account unless you invest it) or reinvesting it in the stock or fund that paid it to you. This decision can have consequences — if your dividends sit in cash, they wouldn’t be able to compound, so I typically like to reinvest dividends I receive!

You’ll have to research which companies and funds offer dividends. As you’re researching, remember dividends can count as income and may cause you to owe income tax!

If you dug this article, head over to our one-of-a-kind investing platform. We aim to make investing straightforward and fun with an easy-to-navigate platform full of education and community.

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