So you want to invest -- or perhaps you're already investing. That's great! After all, relatively few of us have pensions to look forward to in retirement, so it's more on us than ever to sock money away for the future and grow a meaningful nest egg. As you invest, here are 10 rules you should know by heart.
Image source: Getty Images.
Have a long-term view
First off, plan to be patient and avoid short-term thinking and trading. No one can really know what the market will do in any given day or even any given year, so it's generally not productive to act on guesses. Furthermore, if you buy into some great and growing companies at good prices, don't let yourself get impatient if they don't perform as expected quickly. Even great companies can go through occasional downturns or periods of stagnation.
Image source: Pixabay.
Don't act on emotions
Investment results can really suffer if we're led by fear or greed. Too often, people jump into stocks that have surged beyond reasonable values as they don't want to be left out -- only to lose ground when the stocks retreat. And when the market or a solid company's stock takes a dive, it's a mistake to bail out, as you don't know when the rebound will happen.
Remember you're buying companies
It's important to not think of stocks as bits of electronic magic that grow and shrink over time. Instead, understand that they represent pieces of actual companies, entitling you to share in those companies' successes and failures. Thus, for best results, get to know the companies you invest in very well, acquainting yourself with exactly how they make their money, what their growth potential is, how financially healthy they are, how talented and candid their managements are, and what risks and challenges they face.
Image source: Getty Images.
Focus on fees
Whether you're buying shares of companies through a brokerage or investing in mutual funds on your own or through a retirement account, pay attention to the fees you're paying. Consider this example: Imagine mutual funds A and B, which respectively sport expense ratios (annual fees) of 0.7% and 1.7% and that you park $5,000 in each of them annually for 20 years. If they each grow at an annual average rate of 10%, you'll end up with $289,000 in fund A but only $256,000 in fund B. That single percentage point cost you $33,000.
Diversify
You probably know that you shouldn't keep all your eggs in one basket -- and that the maxim applies to investments, too. If you're not paying attention, though, you may overload your portfolio with stocks in a certain niche that has you excited, whether it's solar energy or 3-D printing or Chinese stocks. That can lead to trouble if that niche or sector tanks. Try to diversify across industries and to include some non-U.S. investments, too.
Image source: Getty Images.
Expect to lose money
It can sting when you lose money in the stock market, but it's not a sign of failure. Even the best investors have made regrettable moves. Warren Buffett, for example, apologized in his 1998 letter to shareholders, saying: "[M[y decision to sell McDonald's was a very big mistake. Overall, you would have been better off last year if I had regularly snuck off to the movies during market hours." Expect to lose some money in stocks now and then. As you learn more and start making fewer mistakes, you will likely lose less money, too.
Have a margin of safety
As you buy stocks, aim to have a margin of safety -- by buying them for less than you think they're worth. Undervalued stocks are likely to eventually grow into their intrinsic value, while overvalued stocks may decline, at least for a while. Looking for price-to-earnings (P/E) ratios below the companies' five-year averages is a start.
Boring investments are OK
Don't think that you have to uncover some obscure high-flying stocks to make money. Companies that are huge and well known can still reward you handsomely over time. Check out these examples:
|
Company/Index |
10-Year Average Annual Return |
20-Year Average Annual Return |
30-Year Average Annual Return |
|---|---|---|---|
|
S&P 500 |
4.6% |
5.6% |
7.5% |
|
General Electric |
2.3% |
5.9% |
10.9% |
|
Wal-Mart |
6.8% |
10.8% |
12.6% |
|
Clorox |
9.1% |
10.1% |
13.4% |
|
Johnson & Johnson |
9.3% |
10.5% |
14.1% |
|
Costco |
13.4% |
15.3% |
10.7% |
|
Nike |
17.4% |
11.5% |
21% |
|
United Pacific |
17.8% |
12.2% |
12.7% |
|
Apple |
25.9% |
27.7% |
19.3% |
The industries these companies toil in don't excite many people -- garbage collection, retail, railroads, footwear -- still can perform well. Note that General Electric underperformed the S&P 500 over the past 10 years. That's a reminder that good companies can do so. Apple is kind of exciting, but it's also far from obscure, as it currently sports the largest market value of all companies.
Image source: Getty Images.
Assess your performance
As you invest, be sure to assess your performance every now and then, to make sure that you're outperforming relevant benchmarks. For example, if you're not outperforming the S&P 500 over a bunch of years, you would do well to just invest in an S&P 500 index fund instead. It will save you a lot of trouble and still deliver growth. Even Warren Buffett recommends index funds for most investors.
Keep learning
Finally, for best results, keep reading about and learning about investing. The more you know the more money you'll likely make. Learning more -- and learning from others' mistakes -- can help you avoid common pitfalls such as penny stocks, day-trading, and chasing high-flyers.
