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This article is part of our Better Investor series, in which The Motley Fool goes back to basics to help you improve your returns and be more successful with your investing.
Early in this series, we took a lot of time talking about the various investing strategies you could use to make money in the markets. But knowing a strategy is a lot different from actually putting it into practice.
With the Dow Jones Industrials (INDEX: ^DJI) having set a new low for the year earlier this week and fears of economic troubles on the rise, it's more important than ever to have practical money management skills that you can use to avoid big pitfalls and survive whatever financial storms you have to face. With that in mind, here's a simple four-step path to get you moving in the right direction.
1. Stop letting the banks win
Believe it or not, when most people think about setting money aside, the first place they put it is in a savings account. According to the latest figures from the Federal Reserve, about $7.4 trillion is sitting in savings accounts, short-term CDs, and money market funds.
There's nothing wrong with having some money in readily accessible places like savings accounts. If you have short-term expenses you know you'll need to pay in the next year or two, then keeping liquid cash is a lot smarter than betting on the stock market's movements in the near future.
But procrastination often keeps people from making smarter moves with their savings. And with most savings vehicles paying next to nothing in interest right now, they're not going to get you reach your financial goals.
The easiest way to escape a no-interest bank account is to invest in mutual funds and ETFs. Start with a broad-based fund like Vanguard Total Stock (NYSE: VTI ) and a bond ETF like iShares Barclays Aggregate Bond (NYSE: AGG ) , and split your money between them according to your risk tolerance. That lets you start with a super-simple asset allocation strategy that you can adjust later to your specifications.
2. Pick a sector -- any sector
After awhile, you'll probably discover that you know more about certain industries or companies than others. If you can use your superior knowledge to make better investing decisions, then sticking to a particular sector is a very smart move.
Sector ETFs make a good way to bridge the gap from broad-based funds to individual stocks. For instance, with all sorts of innovation going on in the energy space lately, the Select SPDR Energy ETF (NYSE: XLE ) gives you one-stop exposure to every energy stock in the S&P 500. Other sector ETFs let you buy into anything from consumer stocks or utilities to health care companies.
3. Dip your toes into individual stocks
ETFs are great, but they can't match the potential of buying individual stocks. Within every industry, you'll find winners and losers, with some stocks doing a better job of identifying opportunities and executing on them.
The best place to start is with a simple stock. Philip Morris International (NYSE: PM ) sells cigarettes to foreign markets, and although it faces some of the same regulatory pressures as stateside tobacco companies, it doesn't have to deal with the same liability exposure as companies that target the U.S. market. Similarly, Procter & Gamble (NYSE: PG ) is well-known for its consumer products that you'll find in nearly every American household -- and in many around the world as well. Both pay great dividends, but even better, they have simple business models that anyone can understand.
4. Go off the beaten path
It's easy to invest in a company you know, but the best opportunities often escape common knowledge. Finding a stock that most people don't know about can give you your best returns.
Small, up-and-coming companies are an obvious place to look for little-known companies. One test the Fool uses to find potential winners is the OATS framework, which singles out companies with managers who own shares (O), allocate capital well (A), have a long tenure (T), and act as stewards of shareholder capital (S). One example is Dynamic Materials (Nasdaq: BOOM ) , which has an explosive niche that has worked very well over the long haul.
You're on your way
That's all it takes to put yourself on the path toward becoming an expert investor. Although you'll find that you never know everything, that's part of what keeps things interesting -- and with a big advantage over most investors, you'll have an edge that will pay big rewards throughout your investing life.
Stay tuned throughout our Better Investor series and get the advice you need to succeed with your investments. Click back to the series intro for links to the entire series.