8 Basic Principles of Investing to Help You Save Money Wisely
1. Start Investing NowWe say this not just to discourage procrastination, but because an early start can make all the difference. In general, every six years you wait doubles the required monthly savings to reach the same level of retirement income. Another motivational statistic: If you contributed some amount each month for the next nine years, and then nothing afterwards, or if you contributed nothing for the first nine years, then contributed the same amount each month for the next 41 years, you would have about the same amount. Compounding is a beautiful thing.
2. Know ThyselfThe right course of action depends on your current situation, your future goals, and your personality.
- Current Situation: How healthy are you, financially? What's your networth right now? What's your monthly income? What are your expenses (and where could they be reduced)? How much debt are you carrying? At what rate of interest? How much are you saving? How are you investing it? What are your returns? What are your expenses?
- Goals: What are your financial goals? How much will you need to achieve them? Are you on the right track?
- Risk Tolerance: How much risk are you willing and able to accept in pursuit of your objectives? The appropriate level of risk is determined by your personality, age, job security, health, net worth, amount of cash you have to cover emergencies, and the length of your investing horizon.
3. Get Your Financial House In OrderEven though investing may be more fun than personal finance,it makes more sense to get started on them in the reverse order. If you don't know where the money goes each month, you shouldn't be thinking about investing yet. Tracking your spending habits is the first step toward improving them. If you're carrying debt at a high rate of interest (especially credit card debt), you should unburden yourself before you begin investing. If you don't know how much you save each month and how much you'll need to save to reach your goals, there's no way to know what investments are right for you.
If you've transitioned from a debt situation to a paycheck-to-paycheck situation to a saving some money every month situation, you're ready to begin investing what you save. You should start by amassing enough to cover three to six months of expenses, and keep this money in a very safe investment like a money market account, so you're prepared in the event of an emergency. Once you've saved up this emergency reserve, you can progress to higher risk (and higher return) investments: bonds for money that you expect to need in the next few years, and stocks or stock mutual funds for the rest. Use dollar cost averaging, by investing about the same amount each month. This is always a good idea,but even more so with the dramatic fluctuations in the market in the past 10 years. Dollar cost averaging will make it easier to stomach the inevitable dips.
And remember, never invest in anything you don't understand.
4. Develop A Long Term PlanNow that you know your current situation, goals, and personality, you should have a pretty good idea of what your long term plan should be. It should detail where the money will go: cars, houses, college, retirement. It should also detail where the money will come from. Hopefully the numbers will be about the same.
Don't try to time the market. Get in and stay in. We don't know what direction the next 10% move will be, but we do know what direction the next 100% move will be.
Review your plan periodically, and whenever your needs or circumstances change. If you are not confident that your plan makes sense, talk to an investment advisor or someone you trust.
5. Buy StocksNow that you've got a long term view, you can more safely invest in 'riskier' investments, which the market rewards (in general). This requires patience and discipline, but it increases returns. This approach reduces the entire universe of investment vehicles to two choices: stocks and stock mutual funds. In the long run, they're the winners: In this century, stocks beat bonds 8 out of 9 decades, and they're well in the lead again. According to Ibbotson's Stocks, Bonds, Bills and Inflation 1995 Yearbook, here are the average annual returns from 1926 to 1994 (before inflation):
- Stocks: 10.2% (and small company stocks were 12.1%)
- Intermediate termtreasury bonds: 5.1%
- 30-day T-bills: 3.7%
If you buy outstanding companies, and hold them through the market's gyrations,you will be rewarded. If you aren't good at selecting stocks, select some mutual funds. If you aren't good at selecting mutual funds, go with an index fund (like the Vanguard S&P 500).
6. Investigate Before You InvestAlways do your homework. The more you know, the better off you are. This requires that you keep learning, and pay attention to events that might affect you. Understand personal finance matters that could affect you (for example, proposed tax changes). Understand how each of your investments fits in with the rest of your portfolio and with your overall strategy. Understand the risks associated with each investment. Gather unbiased, objective information. Get a second opinion, a third opinion, etc. Be cautious when evaluating the advice of anyone with a vested interest.
If you're going to invest in stocks, learn as much as you can about the companies you're considering. Understand before you invest. Research, research, research. Read books. Consider joining an investment club or an organization like the American Association of Individual Investors. Experiment with various strategies before you put your own money on the line. Examine historical data or participate in a stock market simulation. Try a momentum portfolio, a technical analysis portfolio, a bottom fisher portfolio, a dividend portfolio,a price/earnings growth portfolio, an intuition portfolio, a mega trends portfolio, and any others you think of. In the process you'll find out which ones work best for you. Learn from your own mistakes, and learn from the mistakes of others.
If you don't have time for all this work, consider mutual funds, especially index funds.
7. Develop The Right AttitudeThe following personality traits will help you achieve financial success:
Discipline: Develop a plan, and stick with it. As you continue to learn, you'll become more confident that you're on the right track. Alter your asset allocation based on changes in your personal situation, not because of some short term market fluctuation.
- Confidence. Let your intelligence, not your emotions, make your decisions for you. Understand that you will make mistakes and take losses; even the best investors do. Re-evaluate your strategy from time to time, but don't second-guess it.
- Patience: Don't let your emotions be ruled by today's performance. In most cases, you shouldn't even be watching the day-to-day performance, unless you like to. Also, don't ever feel like it's now or never; don't be pressured into an investment you don't yet understand or feel comfortable with.
- Fear. If you are unwilling to take any risk, you will be stuck with investments that barely beat inflation.
- Greed. As an investment class, 'get rich quick' schemes have the worst returns. If your expectations are unrealistically high, you'll go for the big scores, which usually don't work.
8. Get Help If You Need ItThe do-it-yourself approach isn't for everyone. If you try it and it's not working, or you're afraid to try it at all, or you just don't have the time or desire, there's nothing wrong with seeking professional assistance.
If you want others to handle your financial affairs for you, you will nevertheless want to remain involved to some degree, to make sure your money is being spent wisely.
By InvestorGuide Staff
Posted in ...Investing