Kudos to you, if you're about to invest for the first time! With pensions becoming increasingly rare, it's more up to us than ever to save and accumulate funds for retirement. Over the long run, it's hard to beat the stock market for building up a nest egg -- but the stock market can also be hazardous to your wealth if you don't know what you're doing. Here are some things that beginners should know.
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Only invest once you're ready
It's great that you're about to invest in stocks, but don't -- unless you're investing money that you won't need for at least five years, if not 10, as the stock market can be volatile. Don't invest if you're not comfortable with some risk and if you won't be able to see your investments rise and fall in value from day to day -- sometimes significantly. Shares of Hasbro, for example, have outperformed the S&P 500 over the past three, five, 10, and 15 years, but a chart of their growth reveals a jagged line, not a straight one. Growth averaged 12.3% annually over the past 15 years, but shares plunged by 30% in 2011 and advanced only 3% in 2014, while surging by 50% in 2010 and 57% in 2013.
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Expect to lose money sometimes
Even the best investors make investing decisions they later regret and occasionally lose money. 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." So expect to lose money now and then, but ideally to make fewer mistakes over time, as you become a better investor. Note, too, that just because a stock you bought has fallen in value, it doesn't mean you've really lost money. You don't lock in a loss unless you sell. What you have is a "paper loss" that can turn into a gain if the stock recovers.
Expect to outperform bonds and gold
Over the long run, stocks tend to outperform alternative investments -- by a lot. Check out this data from Wharton Business School professor Jeremy Siegel, who has calculated the average returns for stocks, bonds, bills, gold, and the dollar, between 1802 and 2012:
|
Asset Class |
Annualized Nominal Return |
|---|---|
|
Stocks |
8.1% |
|
Bonds |
5.1% |
|
Bills |
4.2% |
|
Gold |
2.1% |
|
U.S. dollar |
1.4% |
Source: Stocks for the Long Run.
The annualized rate for stocks from 1926 to 2012 was 9.6%, by the way. Siegel's data shows stocks outperforming bonds in 96% of all 20-year holding periods between 1871 and 2012, and in 99% of all 30-year holding periods.
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Plan to keep your emotions in check
Know that while investing should be a rational practice, we're all human and our emotions can get in the way. Fear can have us rushing to sell shares when a stock we own or the overall market dives, and that's often a very counterproductive thing to do, as we end up with a loss or smaller gains, and we miss out on any recovery that ensues. Greed, meanwhile, can have us jumping into risky stocks without much attention to whether they're undervalued or overvalued -- just because everyone else seems to be making money in them. That often ends badly, when overvalued stocks fall, closer to their intrinsic value. Be as rational as you can, only investing in stocks that seem clearly undervalued and likely to rise, ones with sustainable competitive advantages (such as a strong brand or economies of scale) and solid growth prospects. Then aim to hang on for years, or until you no longer have confidence in them.
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Know that you can always take the easy road
Understand, also, that there's an easier investing path than carefully selecting individual stocks. Instead of that, or in addition to it, you can simply invest in one or more low-cost broad-market index funds, such as the SPDR S&P 500 ETF (SPY +0.15%), Vanguard Total Stock Market ETF (VTI +0.13%), and Vanguard Total World Stock ETF (VT 0.01%). Respectively, they will distribute your assets across 80% of the U.S. market, the entire U.S. market, or just about all of the world's stock market. There are index funds targeting bonds, too, and other segments of the market. Even Warren Buffett has recommended S&P 500 index funds, and they have outperformed managed mutual funds by a large margin over long periods.
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Plan to keep learning
Finally, aim to keep reading and learning about investing, as that's very likely to make you a better investor -- one who makes smarter decisions and makes more money, too.
Don't leave your financial future to chance, hoping that Social Security will be enough. Investing in the stock market -- with your eyes open -- is a great way to build a better future.
