There's no such thing as a perfect investor or investing strategy, but there are definitely smart ones. Different strategies will suit different people for various reasons, but some tried-and-true investing tips can benefit every investor. Here are four things you can do to become a smarter investor.
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1. Use index funds
A stock index is used to group companies based on certain criteria, such as market cap, industry, or ESG mission. An index fund is put together by different financial institutions to mirror a specific index. As an investor, using index funds is one of the best things you can do because it allows you to achieve instant diversification. With just a single investment, you can invest in multiple companies simultaneously.
Take, for example, an S&P 500 fund like the Vanguard S&P 500 ETF (VOO 1.26%). You can gain exposure to 505 of the best-known big-company stocks in the market with just a single investment. Although the top three industries represented in the S&P 500 are information technology, healthcare, and consumer discretionary, the index covers virtually any industry you can imagine.
2. Understand the power of compounding
It's one thing to make money on your investments; it's another thing to have the money your investments make begin to make money on itself -- that's where compounding comes into play. The earlier someone begins to understand the power of compound returns in investing, the more lucrative it becomes. All you need is time on your side, and compounding will do the rest for you.
Let's imagine a scenario where you make a one-time $10,000 investment in a fund that returns 10% annually over the long term. Here's roughly how that investment would stack up after different numbers of years:
- Value after 20 years: $67,200
- Value after 25 years: $108,300
- Value after 30 years: $174,500
This shows how much value can be added just with more time. With each passing year, the total increases more than in the previous year because the money earning the return is greater. In year one, you're earning 10% on $10,000; in year 15, you're earning 10% on over $41,000; in year 29, you're earning 10% on over $158,000. The more time the better.
3. Be knowledgeable of the fees you're paying
Although it's now industry practice to allow free trades, there are still fees investors need to be aware of. Any fund will come with an expense ratio, an annual fee charged as a percentage of the total investment amount. For example, a 0.50% expense ratio means you pay $5 per $1,000 invested per year. Although the differences in percentages may seem small between funds, over time, they can add up and take away from your gains.
Smart investors should also be aware of the fees their 401(k) plan charges. These fees can often go unnoticed, and many become surprised when they find out how much they're paying in 401(k) fees. Part of the reason 401(k) fees get expensive is that they're multilayered. You'll pay an administrative fee to the plan provider, fees on funds held within your 401(k), and even service fees for other features or services you may have opted into. Be knowledgeable of just how much your 401(k) is costing you.
4. Know that all losses aren't worth waiting to recover
It's generally in your best interest to be a buy-and-hold investor who invests with the long term in mind. However, there comes a point where you have to realize that some losses may never recover, and even if they will recover in the future, the opportunity cost may not even make the wait worth it. Sometimes you're hurting yourself more by holding onto an investment than you would be letting it go.
Taking a loss on an investment is never the plan, but sometimes you can find a silver lining. Like the fact that you can use capital losses to offset any taxes you may owe on capital gains. Up to $3,000 of any capital losses you have that are more than your capital gains can be deducted annually. For instance, if you sold some shares for $3,000 in profit and then took a $5,000 loss on an investment, you could deduct $2,000. If your losses exceed the $3,000 deduction limit, you can carry the excess forward to later years.
Smart investors know when it's time to move on.
