Investing is not rocket science! Anyone interested in learning fundamental rules and recommendations for making long term investments can become a successful investor. Over time and with experience, you will develop your investment strategies based on your short-term and long-term goals. As the saying goes, “You’ve got to be it to win it.”
Saving is not investing. Although leaving your money in a savings account may be safest, investing in stocks provides appreciably higher returns over the long term. Their returns typically exceed the inflation rate. Make your money work for you by saving it and deploying it into investments.
Key Reasons To Invest Money
- Help to achieve your financial goals.
- Make your money work for you.
- Compound your growth, particularly if you start early.
- Provide an emergency cushion for unpredictable costs.
- Set aside funds for your children’s college tuition and your retirement.
- Make investments to build wealth and be financially secure.
Investing Rules For Success:
1. Set Investment Goals
If you have never invested before, you may become overwhelmed by the choices, the jargon, and how to begin. Set your investment goals so you can achieve them. You should align these goals with what you want out of life. Investing, at least here, is not about getting rich quick. There are no legitimate schemes to get there swiftly. Instead, think about your financial plan for you and your family and the respective timeframe for achieving specific goals.
Once you understand your goals, you need to establish investment strategies that work best for you. Saving is not investing, but you have to start somewhere.
Money set aside for an emergency fund is an essential “must-have” tool for unexpected costs. Automate your savings as soon as you can and invest these funds in short-term liquid assets readily accessible when needed.
Buying a home means you need to have money for a down payment in the next five years. Here, you would want to invest your money so that you don’t blow these funds away. You want to preserve this money by investing in securities without taking on high risks. Such a vehicle could be a mix of stocks with growth and stable dividends.
529 College Savings tax-deferred plans are savings you invest in your children’s college tuition needs in the next 10-20 years. These 529 plans have various options. If you have a longer-term horizon before needing the money for school, you can use Vanguard target-date funds or aggressive funds for the first few years.
Investing for retirement should be done as early as possible. Retirement accounts have tax-advantages like 529 accounts. You should automate your contributions for your company-sponsored 401K plans, especially if they offer matching contributions. Establish your Roth IRA early as well. Having as much as 25-40 years to build your retirement nest while taking advantage of tax benefits and compounding works its magic. Like college savings plans, there are many investment options to choose from that allow you to invest in higher growth, higher risk securities until you get closer to retirement.
To reach financial independence by a certain age, you will need to save money aggressively for investing. While pursuing this track, you will probably be working hard early in life. Once financially independent and debt-free, you can retire early while pursuing other goals. That may mean continuing to do a job but at fewer hours, pursuing passive income streams, living more simply and entirely but financially secure. You can complement capital preservation for funds needed to pay for necessary living costs with various investments designed for income.
2. Get Your Financial House In Order – Set Up A Large Emergency Fund
Before investing, establishing an emergency fund is a prudent strategy for unforeseen events. Life happens, and being prepared is good financial discipline. When you lose a job or face a medical need, you still have monthly bills like your rent or mortgage. You don’t want to encounter late charges, fees, hits to your credit score, or worse, eviction amid disaster. Putting big bills on your credit card, adding to your balance is the last resort.
If you don’t have an emergency cushion, start saving now so that you can pay for necessary living expenses for a reasonable time, Use an automatic savings plan to withdraw money from your paycheck to funnel into an emergency fund. Invest your emergency money in a readily accessible account such as a high yield savings bank account, a money market mutual fund, or an FDIC-insured money market deposit account. Although you will only earn a small amount of interest now, such a fund should remain liquid.
The Need For Emergency Savings Became More Apparent
The pandemic has caught many people unaware as it wreaked havoc on our health and economy. As a result, those with more significant emergency savings to cover a year’s worth of living costs are in better shape. Having readily accessible funds in liquid accounts such as money market securities helps you avoid borrowing money.
Once the emergency cushion is in place, you are better positioned for financial security. Then, you have less pressure to sell any of your long term investments to take care of necessary living costs.
3. Buy And Hold For Long Term Mentality
It is probably apparent that we favor a long term mentality when it comes to making investments. Staying the course when financial markets get volatile can be difficult.
The recent bear market in March 2020 is a prime example of trying to avoid panicking and selling stocks at the bottom. It can be costly to investors. I recognize the tendency to sell stocks when it seems like the world is ending.
2020: An Extraordinary Year
This year has been particularly extraordinary for many reasons. We began 2020 in great economic shape with the longest bull market. Its abrupt end when the S&P 500 price peaked at $3,386.15 on February 19th, up a fair climb of 4.8% year-to-date. As the coronavirus appeared on our shores, the market became volatile, reaching its S&P 500 price bottomed at $2,237.40 on March 23rd. From peak to trough, there was a 33.9% drop in about four weeks.
Unlike other bear markets, the market proved its resilience even in substantially higher unemployment than we have experienced since the Great Recession. As a result, the S&P 500 reflects the most significant stock reversal in history. Thus far, the S&P 500 is up 59% since it bottomed in March!
Imagine if you sold your stocks on that day? Had you held on to your shares through the turbulence, you would be up over 10% year-to-date. Don’t panic when the market gets volatile as you may cause regrettable errors you will regret. I am sure some people were on the sidelines in March who was opportunistic and jumped into the market in those dark days of March.
The quick market recovery was helped by unprecedented financial support through The CARES Act by the Fed, the Treasury, and Congress. As such, the relief was given to the unemployed, small businesses, and those with a mortgage or student loans. The lesson learned is to think long term, not to panic, and sell your stocks during volatility as markets tend to recover over time.
4. Diversify Your Portfolio
Concentration in two or three stocks or one type of asset is risky. Diversification in investments is the process of reducing risk by spreading your money across a mix of various investment choices. Although you may realize lower returns in a diversified portfolio than the potential return of a single alternative (e.g. Amazon shares), your risk of loss is lower.
The risk associated with owning only one investment of a particular type (e.g. Countrywide Mutual) is called random risk. Random risk can pop up when a specific company does very poorly apart from the rest of the market. These days there are so many ways to diversify your portfolio to reduce risk with various asset classes.
They can range from money market securities, bonds, individual stocks, mutual funds, real estate, precious metals, and high-risk collectibles. You need to find out what is suitable for you. I have very good (and some bad) experiences with some of these categories.
5. Asset Allocation With Rebalancing Annually
Asset allocation is a form of diversification among different classes of assets. The average investor will predominantly have various stocks either bought individually or through mutual funds.
It is prudent to diversify by considering a mix of money markets funds, stocks, bonds, and real estate investments. Age, risk tolerance, life cycle, and preference often determine your proportion of stock exposure.
There is a common rule of thumb for stock allocation of subtracting your age from 100. A person of 35 years should allocate 65% of their investments to stocks, while a 75-year-old person should hold no more than 25%. Some suggest using 110 rather than 100, which would allow for higher stock proportions in your portfolio.
Review your portfolio annually to rebalance these assets if you have too much exposure to stocks, for example. Automatic portfolio rebalancing is often available to employees as a valuable feature when they participate in employer-sponsored retirement plans.
6. Gauging Your Risk Tolerance
There are trade-offs between risk and return. Investments come with risks that may vary significantly. Risks and returns are positively correlated. That is, returns tend to go in the same direction as risks. Someone seeking potentially high returns on their securities will need to take more significant risks. For example, a high return opportunity with little risk may be paying off high-interest credit card balances if you have the money to pay it off. I digress on purpose.
If you are averse to risk and want a completely safe investment without having to worry about losses, your best bet will be to invest your money in US Treasury securities. The full faith and credit back these AAA securities.
T-bills have the shortest maturities of all Treasuries and are considered risk-free investments. But, they pay a very low return, especially nowadays.
Being too ultra-conservative will shortchange your potential for acceptable returns. Find the right balance by factoring your tolerance for risk into your investment approach. Generally, the younger you are, the better you should handle greater risk in your portfolio. As long as you are working, can pay your monthly bills, have an emergency cushion, you should take on risk.
7. Compound Interest Is Far Better In Building Your Wealth
When investing for college savings, retirement, or investment accounts, compounding plays a magical role. Assuming you don’t withdraw any money, compounding allows you to earn interest on interest on your balance in these accounts. That is, your principal continues to rise with earned interest. Compound interests work to benefit from added interest to your principal.
Understanding compound interest fuels the urgency to invest your money as early as possible. Your balance grows at its interest rate so long as you aren’t tempted or have a need to withdraw money. By adopting good financial habits of investing money, compounding over time is what builds wealth.
How Compounding Works On Retirement Accounts
Saving for retirement is a form of investing for the long term. Using a simple example and a compound interest calculator, Maria, age 25, initially investing $2,000 in her employer-sponsor 401K plan (ignoring tax benefits and employer-matching) and automates $1,000 per month from her paycheck to be deposited in her account. Based on an 8% average annual return, her retirement fund would be close to $1.4 million by the time she is age 55.
Maria changes her mind, decides to increase her monthly contribution to $2,000, and will leave her money in the plan longer until age 60. Maria’s retirement fund will grow to $4.154 million. Using a compound interest calculator, you can change the initial investment and monthly contributions, annual return, and the number of years to calculate a targeted amount for you. The effect of compounding has significant positive ramifications on your money, particularly when you start to invest early in your life.
8. Don’t Gamble When Investing
Many people consider investing as a form of gambling. While some forms of investing are like gambling, they are different. According to Merriam-Webster, “Gambling is the practice or activity of betting: the practice of risky money or other stakes in a game or a bet.”
Casinos, poker, greyhound, and horse races are fun entertainment sources but not a reliable investment choice. Chances are very likely you will lose more than you gain. The games are designed for the “house” to have high returns, while yours will be in the negative column.
Investing is not gambling. The big difference between investors and gamblers is that investors have substantially more publicly available resources to rely on to make their decisions. Investors can reduce their losses by diversifying their portfolios, not panicking during market turbulence, and doing their due diligence.
On the other hand, investors can be more like gamblers when they trade on anonymous tips, buy penny stocks, or speculate on securities they don’t understand or engage in day trading.
Day trading is not investing. Day traders require different skills, more capital, huge time commitment, and understanding the market forces. Day trading has various risks. By definition, its profits are short term and taxed as ordinary income. Investors’ holdings of more than a year benefit from the lower capital gains rate.
9. Avoid Short Selling
I am also uncomfortable with the practice of short selling. Short selling is a speculative strategy that can be dangerous if you don’t know what you are doing. When a trader or investor short a stock, they sell the shares on the expectation they will profit if the stock goes down because they believe the stock is overpriced. It’s legal, but it seems to go against the philosophy of investing. Company management runs their companies for future growth, so they are particularly hostile to short sellers. Just ask Elon Musk, CEO of Tesla, about short sellers.
The danger to short-sellers is that they are wrong, and they could be facing unlimited losses if the stock continues to rise. That particular security could be anointed a favorite among the street, misunderstood, or getting a generous buyout offer.
10. Don’t Buy On Margin
When buying shares in a company, you may use some of your own money and borrow the rest from your broker. Margin calls are an extension of credit, with the securities acting as collateral. When the company’s shares decline in price, your broker will ask you to put up more money towards the borrowed amount or to sell the shares. The broker uses margin interest to protect themselves from losses on the loan to you. Both the Fed and FINRA set industry rules for investing in the market. Your broker usually sets the minimum margin requirement. They could be stricter than federal guidelines.
Margin buying offers higher profits and higher risk through the added leverage. By paying only a small portion of the total amount, investors amplify their purchasing power. However, when financial markets are volatile, brokers make margin calls. These calls boost the losses suffered as well. The higher the amount borrowed, the greater the risk. Given these risks, I have always avoided using margin to buy stocks.
11. Don’t Be Greedy – Some Discipline Is Needed
Wall Street saying, “Bulls make money, bears make money, pigs get slaughtered.” The market is the wrong place to get greedy by overstaying your welcome with a particular stock. Even the best companies stumble once in a while. Stocks do rise over the long term, but they often pause or decline based on a range of factors, including an economic downturn, industry problems, or internal issues with the company.
Trim your stock positions that have appreciated 20% -25% after your purchase. You can sell a small portion to lock-in some profits. I have done this regularly for years. My reason for doing so is that awful experience of thinking that a rising stock will continue to do so. That euphoria can fade quickly. Stocks will pause, reverse, and sometimes fail over time. After a few of these experiences, where my gains disappeared, to be replaced by eventual losses, I changed gears to take small profits at a time.
12. Don’t Chase IPOs Right After Its Pricing
Many individual investors want to participate in hot IPOs but aren’t typically able to buy at the IPO price. Instead, many investors buy after the new issue is trading in the secondary market. They see the excitement surrounding this stock, which more than likely rose 20% on its first day of trading. Enthusiasm happens as the new stock name attracts all investors. Typically, institutional investors add to their IPO allocated positions as part of their participation.
Don’t chase these stocks after their initial pricing for a while. Statistics show that in the long run, IPOs tend to underperform. There are several reasons for these stocks to do poorly one year after the IPO.
13. Why IPOs Perform Poorly In The Long Run
Often, company management is young and inexperienced with communicating with their new shareholders publicly. As part of the deal for taking the company public, the underwriters will support the newly issued shares and discourage flipping shares (selling the shares after the initial rise) from those investors who received stock at IPO price.
The underwriters will solicit lockup provisions from previous private owners of the stock for 90 days or longer. The private owners are usually the founders who own many shares, their management, and key employees. When those provisions expire, some of these earlier investors will want to sell shares, putting pressure on the stock.
Along with these impacts on the stock, the company may miss some revenue or earnings results compared to expectations. Analysts may revise forecasts. The company may experience delayed product rollouts. As a former analyst, I had substantial experience with newly issued shares that can’t cope with potential issues in the first year of their public debut. Facebook, Groupon, Lyft, and Uber all had problems and underperformed significantly within their first year. After a stock’s immediate rise, there often is a better price you can pay. Learn from other people’s mistakes, mine included.
14. Learn As Much As You Can
There are so many ways to learn about investing in building up your knowledge, skills, and experience. Never stop learning. There are so many opportunities to learn about different kinds of investments, philosophies, and strategies. Resources are readily available.
I have recommended simulated stock games to many who want to learn about investing. They are fun, have resources, and do give you “hands-on” experience without losing money. I have played with my kids and college business students to great success. My college students have told me that they regularly invest in the market on their own after playing the game.
To learn how to invest, consider watching CNBC Squawk Box in the AM and Mad Money with Jim Cramer in the evening. Read articles from thestreet.com, Investors Business Daily, and SeekingAlpha. I read everything possible, written by Warren Buffett. Annually, I read Buffett’s annual letter to shareholders for its golden nuggets.
Investing Classics Worth Exploring:
The Intelligent Investor by Benjamin Graham
Security Analysis by Benjamin Graham and David Dodd
One Up On Wall Street by Peter Lynch
Common Sense Investing by John C. Bogle
A Random Walk Down by Burton Malkiel
I could fill a page on books I could recommend. I read all or parts of these books when I became a security analyst. However, having your own experience as an investor will speak volumes to you. If you are going to doing your own investing, you have to research companies, listen to conference calls or read transcripts, SEC documents, and understand what others are thinking.
One way to begin investing is by buying low-cost index funds that provide immediate diversification. I highly recommend going in this direction.
15. Be Humble
Anyone who tells you that they never made a mistake while investing is probably lying. Investors make lots of mistakes and hopefully learn from them. Expect to eat humble pie on occasion. Otherwise, it may mean that you are not taking enough risks. The smartest investors I know personally or from a reading of their experience know the impact of feeling wrong from losing money on an investment.
16. Be Patient
Learning how to be patient about an investment you made is essential. Sometimes you buy a stock too early, and it is not moving the way you like. Be patient and try to learn more about it. As we said earlier, there are no get-rich-schemes.
I have learned patience by purchasing small amounts of stock, such as an eighth of the expected larger position. This way, I can benefit from dollar-averaging if the stock continues to decrease my share cost. At times, you may not get a chance because the stock took off and got expensive. I may kick myself for not buying more initially and be opportunistic should there be a chance the price declines in the future.
Alternatively, there will be times when you realize you were wrong about your expectations. You made a mistake and decide it is better to sell now and move on. It could be that it was a surprise to all holders or didn’t fully understand its kind of company. As much as I try to do my research, I was wrong. Mistakes, I have made a few.
By following our investing rules, you can become a successful investor. Investing is the best way to build wealth and become financially secure. Start as early as possible so you can take advantage of the long-term horizon and compounding growth. There are many ways to learn how to invest, but the best way is through experience.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.