Everyone wants to make money in the stock market, but there's always the challenge of risk versus reward -- the more you risk, the higher your potential reward. But what if you're a cautious person and hesitate to take chances with your money?
There's nothing wrong with that. You just need to find ways to invest that can help you make money while reducing risk. Here are five brilliant money-making strategies for investing while keeping risk to a minimum.
1. Focus on dividend stocks
One way to invest cautiously is to buy stocks offering healthy dividends. This way, if the stock market goes through a volatile period, you'll still make money on your investments, even if prices drop.
History has shown that dividend stocks outperform stocks that don't pay them. During the 40-year period between 1972 to 2012, dividend-paying stocks were up an annualized 9.5%, versus only 1.6% for their non-dividend-paying peers. This is one area where a cautious investor may even outperform a more aggressive one.
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2. Maintain a long-term outlook
The old saying goes that the way to make money in the stock market is to buy low and sell high. But too often, investors find themselves playing the opposite game: They buy on emotion and momentum when stocks are rising, then panic sell when their equities drop, and end up selling low.
That's human nature. When things are going great, you don't want to miss out, so you buy, but when stock prices drop so much your stomach aches, it's natural to want to sell and never see that security again.
A brilliant strategy -- if you can master it -- is to keep a long-term focus and hold through periods of volatility. If you develop a value-investing strategy where you identify stocks that are selling at bargain prices, hold on to them as long as the company news continues to be positive.
If you want to take a higher risk and buy growth stocks, hang on to them during turbulent times and give them time to grow. The market will ebb and flow and take stock prices along with it, but if your company is solid, you'll be able to weather the storms and come out the other side on Cloud 9.
3. Always have cash on hand to take advantage of opportunities
In order to use strategy No. 2, you need cash. Savvy investors will make it a top priority to have cash on hand at all times so they can take advantage of opportunities. (This would be in addition to the three to six months of living expenses that you set aside for emergencies, but as a cautious person, you probably already have that security blanket in place.)
4. Build a diversified portfolio
The terms "asset allocation" and "diversified portfolio" are magic to the ears of cautious investors because they lower portfolio risk. By diversifying, you'll spread your money among different asset classes -- stocks, bonds, real estate, and overseas investments -- and different industry sectors. This way, when one area is out of favor, another one may be booming, and your portfolio will have a steadier personality.
5. Try to match the market, not beat it
If you want to "beat the market," where the market is the S&P 500, you'll need to take on more risk. But if you're cautious, you probably will be happier with mirroring the returns of the market instead of beating it, at least with the more aggressive part of your portfolio. One way to do this is to buy exchange-traded funds (ETFs).
ETFs trade like stocks but are very different. Each one holds a basket of stocks in a particular sector or based on a specific index and can have anywhere between 25 and 7,000 stocks.
For instance, instead of buying a single stock like Apple or Microsoft, you could buy a technology ETF like the Vanguard Information Technology ETF. Not only will you own both companies by buying this fund, but you'll also own more than 360 other technology stocks. This minimizes your exposure to one security finding itself in trouble. This ETF has returned an average of 19.35% annually during the past 10 years and 12.07% per year since its inception in 2004.
You can also diversify with ETFs by buying from different sectors, such as pharmaceuticals, energy, or consumer staples.
If you're cautious, it's a bit more challenging to make money in the stock market -- but you're up to the challenge. By following the above five strategies, you'll be able to reap the financial rewards of investing without compromising your cautious nature. That's a brilliant move, for sure.
