If you are reading this, you probably understand that investing is smart and that a lot of people have made a lot of money doing it. The problem is, you’re scared to lose all of your money, and you don’t want to do the work involved.
Investing is the key to financial success. If you don’t invest to build a nest egg and accomplish financial goals, you’ll have nothing to show for a lifetime of labour. Of course, you don’t want to invest your money just anywhere you need to be smart about what you invest in so you can grow your wealth and become financially free. To make sure you invest the right way, here are nine investing rules you should know by heart.
1. Draw a personal financial roadmap
Before you engage at all in any investment, you must have your plans clearly laid out.
How much do you want to invest?
Why are you investing?
What do you know about the investment option? Do we have sufficient information to go by?
The time frame of the investment
The returns you are expecting from the investment
The RISKS involved
You must also know and understand your risk appetite. The reward for taking on risk is the potential for a greater investment return.
2. Invest for the long term
An investor who puts money aside over the long term for the proverbial rainy day is far more likely to achieve his or her goals than someone looking to ‘play the market’ in search of a quick profit. The longer you invest, the bigger the potential effect of compound performance on the original value of your investment.
Many investors will be familiar with the term ‘compounding’ from owning cash savings accounts. The term refers to the process whereby interest on your money is added to the original principal amount and then, in turn, earns interest. Over time compounding can make a huge difference. The same can be true of investment returns, so long as you reinvest the income that you receive.
3. Diversify your portfolio
Minimizing investment risks means not only understanding how investments work, but also ensuring you don’t put all your eggs in one basket. While you may have a particular company you love, if you sink your entire nest egg into buying its stock and it turns out the CFO was a thief who was cooking the books, you could lose everything. To reduce the likelihood of big losses, spread your money around a mix of different assets. You could, for example, put some of your cash into big companies in the U.S., but also invest in emerging markets or real estate with the hope that if some of your investments perform poorly, others will do well.
If diversifying your portfolio and getting the right mix of different assets sounds complicated, you can opt to invest in target-date retirement funds that give you exposure to a mix of different assets appropriate for your age and goals. Robo-advisors can also help you build a diversified portfolio without requiring you to be hands-on.
4. Invest for a maximum real return
This means the return on invested dollars after taxes and after inflation. This is the only rational objective for most long-term investors. Any investment strategy that fails to recognize the insidious effect of taxes and inflation fails to recognize the true nature of the investment environment and thus is severely handicapped. It is vital that you protect purchasing power. One of the biggest mistakes people make is putting too much money into fixed-income securities.
Today’s dollar buys only what 35 cents bought in the mid-1970s, what 21 cents bought in 1960, and what 15 cents bought after World War II. U.S. consumer prices have risen every one of the last 38 years. If inflation averages 4%, it will reduce the buying power of a $100,000 portfolio to $68,000 in just 10 years. In other words, to maintain the same buying power, that portfolio would have to grow to $147,000— a 47% gain simply to remain even over a decade. And this doesn’t even count taxes
5. Don’t go with the flow
Investing is not easy. As we saw to great effect in 2008, following the collapse of US investment bank Lehman Brothers, unexpected or adverse newsflow can have a significant effect on stock market performance. Indeed, there have been times when highly cash-generative, defensive businesses capable of creating value in a range of market conditions have been hit by the same negative sentiment that has driven down the price of stocks more sensitive to economic cycles and those that are poorer quality.
6. Create and maintain an emergency fund
Most smart investors put enough money in a savings product to cover an emergency, like sudden unemployment. It’s ideal to make sure you have up to six months of your income in savings. Automating a tiny bit of your income into a savings account can help you ensure that you always have some liquid enough cash for emergencies.
7. Invest in what you understand
While a well-constructed portfolio can produce a healthy return for investors, the converse is also true. It is easy to incur permanent losses by putting money into an asset that behaves in an unexpected way. Investors should always set aside time to try and understand what it is they want to hold.
8. Monitor your investment
Expect and react to change. No bull market is permanent. No bear market is permanent. And there are no stocks that you can buy and forget. The pace of change is too great. Being relaxed, as Hooper advised, doesn’t mean being complacent.
Consider, for example, just the 30 issues that comprise the Dow Jones Industrials. From 1978 through 1990, one of every three issues changed because the company was in decline, or was acquired, or went private, or went bankrupt. Look at the 100 largest industrials on Fortune magazine’s list. In just seven years, 1983 through 1990, 30 dropped off the list. They merged with another giant company, or became too small for the top 100, or were acquired by a foreign company, or went private, or went out of business. Remember, no investment is forever.
9. Learn from your mistakes
The only way to avoid mistakes is not to invest which is the biggest mistake of all. So forgive yourself for your errors. Don’t become discouraged, and certainly don’t try to recoup your losses by taking bigger risks. Instead, turn each mistake into a learning experience. Determine exactly what went wrong and how you can avoid the same mistake in the future.
The investor who says, “This time is different,” when in fact it’s virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing. The big difference between those who are successful and those who are not is that successful people learn from their mistakes and the mistakes of others.
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