How to Make Money Investing

Christopher Moser is an investment consultant for Northwestern Mutual.

Even if you’re new to investing, you probably already know that it can be a powerful way to build wealth. But before you get too far into the details, it’s good to have a clear understanding of how an investor actually makes money.

Below, you can find out how different types of investments might be profitable. You’ll get an idea of how much you might be able to grow your money by putting it in the market. And you’ll see some tips for building a smart investing strategy and answers to popular questions.

How do investments make money?

First things first: It’s important to note that investments don’t always make money. The stock market typically goes up over time. But it also declines, and any individual stock can move up or down in value. That’s why a big part of investing involves managing common risks.

OK, with that out of the way, your investments could make money in two ways.

• You could get income in the form of a cash payout called a “dividend,” a yield from a bond or an interest payment. Some companies pay these out monthly, quarterly or annually.
• You could sell an asset for more than you paid, earning you a profit.

Earning income from an asset

You might purchase investments that pay you an income without needing to sell the underlying asset.

Some companies, for example, share a portion of their profits with shareholders as dividend payments, which can be paid quarterly, annually or even monthly depending on the company. Dividend stocks and real estate investment trusts (REITs) are examples of assets that can provide income in this way.

Other types of investments, like bonds and certificates of deposit (CDs), are designed to be more like debt. An investor acts as a lender. As long as you keep a bond or a CD, you’ll receive interest payments, according to the terms that you agreed to when you purchased the asset, until the asset matures and you receive back what you paid in.

This is attractive for investors who want to earn a passive income without needing to regularly buy and sell assets. After some upfront work to get things started, there’s very little maintenance.

Selling assets for a profit

When you make an investment, you are essentially purchasing an asset. If that asset increases in value after you’ve bought it, you can make money by selling it. Your profit depends on the purchase price compared to the final sale price. (If your asset decreases in value, you’ve got a loss on your hands.)

This strategy can apply to any asset class, but is particularly common for things like stocks, commodities and alternative investments (like collectibles or art). It’s also the reason for the phrase “buy low, sell high.”

When you sell an investment for a profit, you’ll need to pay capital gains taxes on that profit. These can be lessened by holding an asset for at least 12 months before selling, at which point you’ll qualify for the more favorable long-term capital gains tax rate.

Examples of how money grows with investments

How much your money might grow by being invested will depend on a few things. Each thing interacts with others to affect your total return. Some big factors include which investments you buy, how much risk you’re willing to take on, your investment timeline and the overall state of the markets and broader economy.

If we look at data about the performance of different asset classes, it’s possible to run some projections. Let’s think about the category of stocks called “Large Cap,” which means these are stocks of companies that have a market capitalization (the company’s value) of $10 billion or more. From 1926 through 2023, Large Cap stocks saw an average annualized return of 10.3 percent. While past performance does not guarantee future returns, we can get some general ideas. If you invested $10,000 today and never invested another dollar, but your portfolio earned 10.3 percent each year, it might grow to:

• $16,699 in 5 years,
• $27,887 in 10 years,
• $77,773 in 20 years,
• $216,891 in 30 years, and
• $604,864 in 40 years

It gets even better if you add an additional $100 each month after your initial investment. Your portfolio would be boosted to:

• $24,505 in 5 years,
• $48,727 in 10 years,
• $156,731 in 20 years,
• $457,930 in 30 years, and
• $1,297,907 in 40 years!

Keep in mind that past performance is no guarantee of future performance.

Build an investing strategy

The investing strategy that works best for you will depend on how much risk you can stomach, how long your money can be invested before you need it and your personal financial goals. But there are some investing principles that make sense for everyone. These include the following:

Diversify to minimize risk

When you invest in a single asset, you’re concentrating your risk. This can sometimes lead to a big payday. But it can also lead to big losses, including losing your entire investment. Diversification involves spreading out your assets to reduce this concentration so you can better manage your risk and volatility.

You can diversify simply by buying many different company stocks. You can also buy stocks of different types of companies—for example, by investing in a mixture of company sizes called Small, Mid-, and Large Cap stocks. You can also diversify across asset classes by purchasing both stocks and bonds or other assets. Lots of investors do both kinds of diversification.

One easy way to quickly diversify your portfolio is investing in shares of mutual funds or exchange-traded funds (ETFs). These are made up of many different investments, so they have some diversification built in.

Invest regularly and consistently

You might worry about jumping into a market at the wrong time—getting in at a market high instead of a low. While all investors dream of maximizing gains by buying in at the absolute lowest possible price, the truth is that it’s incredibly hard to time the market in this way. And trying to do so can mean missed opportunities and growth.

A common approach is called dollar-cost averaging. You invest regularly and consistently over time to average out your purchase price and reduce volatility. This approach helps build a healthy habit of consistent investing. For example, if you had $1,200 to invest, you might invest $100 a month for 12 months instead of investing all at once as a lump sum. Your first $100 purchase might be at $50 a share, but the stock price could go down. The next month, your $100 purchase might be at $25 a share, making your average price per share $33.33.

Stay invested for the long haul

Some investors try to predict the best times to buy and sell based on how they believe the price will move in the future. While a few investors may have success with this strategy, the vast majority don’t. In fact, they may end up with worse returns than had they simply left their money invested in the market, where it could compound and grow over time.

Let’s say that 20 years ago you invested $100,000 in an index fund that mirrors the S&P 500, which includes 500 large companies. If you’d left it alone, you would’ve seen it grow to just under $640,000 now.

But if you had taken it out of the market at times and put the money into another financial tool, you might miss some huge gains. Let’s say you missed the 10 best market days during those 20 years—you’d have only $287,500. That’s about $350,000 less than if you had just left the money alone.

The general rule is that the earlier you get started and the longer you can keep your money invested, the better off you’ll be.

Making use of tax-advantaged accounts

Keep in mind that the type of account you use to invest can have a big impact on your overall growth. Certain types of accounts, for example, are tax-advantaged. This means that they are taxed more favorably than regular brokerage accounts. Taking full advantage of these accounts can mean more money in your pocket instead of in Uncle Sam’s coffers.

Let’s use retirement accounts like traditional 401(k)s and IRAs as examples. When you invest in these accounts, you lower your taxable income in the year that you make the contributions. Those contributions then grow tax-free until you make withdrawals during retirement—when you will hopefully fall into a lower tax bracket.

Roth accounts work differently. Instead of being tax-deferred, you pay income taxes on your contributions upfront. Then, when you make withdrawals during retirement, they’re completely tax-free.

There are even more types of tax-advantaged accounts. Earnings withdrawn from college savings funds like 529 plans, for example, are typically tax-free as long as you use the funds on qualified educational expenses. The same goes for earnings in health savings accounts (HSAs), which are tax-free as long as you spend the money on health-related expenses.

Get expert help from your advisor

As you learn about how to make money investing, keep in mind that you get few guarantees. But with the right habits, like setting a strategy and staying invested for the long term, you set yourself up for greater chances of success.

Connect with your Northwestern Mutual financial advisor. They’ll get to know you and understand your goals and situation and then help design an investment strategy. That strategy can evolve for every stage of your life. And your advisor can show you how your investments work with additional financial options, like permanent life insurance, to help you reach your financial goals.

All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss.