Investing in the stock market can be intimidating, but it's one of the best ways to build wealth and create a robust retirement fund.
However, investing properly can be tricky. In fact, when given a short investing quiz, roughly two-thirds of Americans answered most questions incorrectly, according to a report from the Financial Industry Regulatory Authority (FINRA).
If you're already investing in the stock market, that's a great start. But you must avoid these common investing mistakes that can potentially derail your retirement plans.
1. Investing too aggressively
Stocks generally have higher rates of return than bonds. An aggressive investing approach involves allocating the majority of your portfolio toward stocks.
Investing aggressively allows your savings to grow substantially when the stock market is surging, but it can also result in steep losses if the market crashes. That's why it's usually best to invest aggressively when you're younger and still have plenty of time left before retirement. If you're only a few years away from retirement and the vast majority of your portfolio is allocated toward stocks, a market downturn could devastate your retirement plans because your investments won't have much time to recover.
2. Investing too conservatively
If you're concerned about a market downturn wiping out your savings, you may be tempted to allocate the majority of your portfolio toward bonds to limit your risk. While this can be a wise move if you're close to retirement, it could potentially be dangerous if you're younger.
On average, bonds have a rate of return of around 5% to 6% per year, compared to around 10% per year for stocks. Although stocks are riskier in the short term, they also make saving a significant amount for retirement easier. If you're investing primarily in bonds, you'll have to contribute much more per month to reach your savings goals.
How much you should invest in stocks versus bonds depends on a few factors, including your age and risk tolerance. One rule of thumb is to subtract your age from 110 to get the percentage of your portfolio that you should allocate to stocks. For instance, if you're 40 years old, you should aim to invest 70% of your portfolio in stocks and 30% in bonds. This is just a general guideline, though, and you might invest more or less in stocks depending on your tolerance for risk.
3. Not diversifying your portfolio enough
You don't want to put all your eggs in one basket, as the saying goes. If you throw your life savings behind a single stock and that company fails, you stand to lose a lot of money. But if you diversify your portfolio and invest in many different stocks, bonds, or other securities, your money will be much safer.
Exactly how much you diversify will depend on your investing style. If you prefer to invest in individual stocks, aim to put money in at least 10 to 15 different stocks to limit your risk as much as possible. If you want to err on the safer side, invest in index funds or mutual funds to spread your cash across hundreds or even thousands of different stocks.
Of course, you'll always be subject to some amount of risk when you invest in the stock market. Even if you invest in the safest index funds out there, you could still see your portfolio plummet if the market as a whole takes a turn for the worse. But by diversifying the best you can, you may not be hit quite so hard.
Investing for retirement can be tricky, but understanding the basics can make it easier to build a healthy stash of savings while minimizing your risk. By avoiding these mistakes, you'll give yourself a much better chance of achieving your retirement goals.