Author: Todd Campbell | August 14, 2019
This road leads to successful investing
There are no guarantees in life, but investing for the long haul has historically given people the best shot at financial freedom. Yet, many people choose not to invest in stocks or they fail to make the most of the investing options available to them. That could be a big mistake. If your goal is financial security, then following these 12 tips could help you build a bigger nest egg, regardless of if you consider yourself to be an investment novice or pro.
No. 12: Put time to work for you
The sooner you start investing, the greater chance you have of securing financial freedom. Why? Because compound interest, or the ability to earn interest on your interest, can give a big boost to your portfolio. For instance, it takes only $500 per month for a 25-year old to build a $1 million portfolio by age 65, assuming a hypothetical 6% annual return. However, it would take $1,000 per month for a 35-year old and over $2,200 per month for a 45-year old to reach that goal.
No. 11: Invest using dollar-cost averaging
There’s no guaranteed way to avoid losing money in the stock market, but dollar-cost averaging is a great way to reduce the risk of losing money over time. By contributing the same amount of money at a fixed interval, such as monthly, you’ll be buying more shares when stocks are falling and fewer shares when they’re climbing. This reduces the average cost of your investment, increasing the odds of successfully making a profit.
No. 10: Embrace a workplace retirement plan
Most employers offer an employer-sponsored retirement plan, such as a 401(k) or 403(b) retirement plan. Surprisingly, many workers don’t take advantage of the tax savings associated with these plans. In 2019, employees can stash away up to $19,000 in pre-tax money and employees over age 50 can contribute an additional $6,000, for a total of $25,000. Participants won’t pay federal income taxes on the money they contribute to these plans, or their profits, until the money is withdrawn. Some employers will even match contributions, making these plans a no-brainer.
If you’re self-employed, you have options too. For example, a Simplified Employee Pension (SEP) IRA allows entrepreneurs to contribute 25% of their compensation up to $56,000 in 2019. Many financial services firms also offer a solo-401(k) that may make even more sense, depending on your situation.
No. 9: Don’t forget about IRAs
Individual retirement accounts (IRA) are yet another great way to invest money and reap tax savings, even if you’re covered by a retirement plan through your employer.
For instance, if your household income is below annual limits, you can still deduct contributions to a traditional IRA if you’re also covered by a workplace plan. In 2019, a person who files their income taxes as married, filing jointly, can fully deduct contributions up to $6,000 ($7,000 if over age 50) if household income is below $103,000. If the spouse of a person contributing to a traditional IRA is covered by a workplace plan, then the contribution is fully deductible if income is below $193,000.
If you prefer a tax break in retirement, a Roth IRA is also an option. Unlike a traditional IRA, you pay taxes on money contributed to a Roth IRA upfront in exchange for tax-free withdrawals later. You can learn more about the differences between traditional IRA’s and Roth IRA’s here.
No. 8: Focus on fees
If you use a brokerage firm or an investment management firm to invest your money, you’ll pay commissions or management fees, respectively. Unfortunately, these costs can take a stiff toll on your portfolio over time. According to Vanguard, an investor paying 2% fees on a $100,000 investment returning an average 6% annually for 25 years would end up with an account balance that’s $260,000 smaller than if they didn’t pay any fees at all.
Because commissions and management fees add up, you’ll want to comparison shop. After all, your money should benefit you, not someone else.
No. 7: Diversify investments
We all dream of investing in the next Amazon.com (NASDAQ: AMZN) and then retiring early with a million-dollar portfolio. Sadly, those type of investments are few and far between, and many once-promising investments will go sour.
To reduce the risk you’ll lose all your money if a stock goes belly up, invest across multiple sectors, such as healthcare, financials, and technology, and include small-cap, mid-cap, and large-cap stocks in your portfolio, rather than go all-in on one or two stocks.
No. 6: Look for great leaders
When you invest in a company, you’re putting your trust in that company’s management to make smart decisions that grow revenue, boost earnings, and ultimately, deliver shareholder-friendly returns. Unfortunately, not all companies are run by talented leaders. Invest in a company run by a poor management team and you could wind up saddled with big losses.
You can’t eliminate the risk of bad management entirely; but you can reduce it by investing alongside highly ranked CEO’s who also own a lot of shares in the company they run. A big stake makes it likely their choices will be aligned with your interests, and since great managers often inspire great employees, a high CEO rating on a site like Glassdoor can indicate a manager worthy of trusting.
No. 5: Own innovative and disruptive companies
Thomas Edison, the founder of General Electric (NYSE: GE), didn’t just invent the light bulb, he helped change how people live. Innovative and disruptive companies aren’t common, but their impact on your investment success can be significant. If you’re wondering how to spot revolutionary products or services, consider how Amazon.com transformed shopping, Facebook changed how people communicate, or how Netflix helped change how we view television shows and movies.
No. 4: Buy dividend stocks
Dividend-paying companies reward shareholders with regular income that can substantially increase returns. Dividend payments can be used to supplement other income, or even better, they can be used to buy more shares. Reinvesting dividends can pay-off big. According to Schroders, reinvesting dividends nearly doubled the return of the MSCI World Index to 640% from 323% from January 1993 through March 2018. Because reinvesting dividends helps investors benefit from compounding and dollar-cost averaging, this is a great way to give your portfolio a lift.
No. 3: Make it automatic
Life gets busy. And a busy life can distract you from your investment plan. Instead of leaving it to chance, automating your dollar-cost averaging investments and adding an auto-escalation feature to your workplace retirement plan may be best. Most mutual fund firms and brokerages allow you to schedule regular, automated, investments over the phone or online, making it easier to regularly invest in IRAs or taxable investment accounts. Similarly, employers are increasingly incorporating an auto-escalation feature that systematically increases how much of your paycheck you contribute to your retirement plan every year. These automated strategies take the guesswork out of timing your investments and they can help you reach your investment goals faster.
No. 2: Build an emergency fund
Too little cash poses a big problem for many Americans. According to the Federal Reserve, over a quarter of people would struggle to pay an emergency expense of just $400. An unexpected illness or job loss could be even more disastrous. To avoid tapping your investment portfolio to get through a financial rough patch, set aside a little money every month to cover at least six months of expenses. Doing so could keep your financial plan from being set back years, especially if you’re forced to sell your stocks after they’ve fallen, such as during a bear market.
A stash of cash can also come in handy because it will give you the financial flexibility to buy stocks on sale when everyone else is selling.
No. 1: Think long, long, long-term
There’s no secret sauce to stock market success, but perhaps, the best (and arguably, hardest to follow!) advice is to buy shares in great companies and hold them for decades.
Sticking with stocks through bear markets can be hard, but historically, patience has outperformed short-term trading. Why? Because it’s hard to know when it’s safe to buy shares after selling them, and that can lead to missing out on some of the stock market’s best performing days. For example, an investor who stayed the course through thick and thin earned a 339% return between Jan. 1, 1997 and Dec. 31, 2016; however, if they missed the 30 best performing days during that period, they’d have lost money, according to JP Morgan Asset Management.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Todd Campbell owns shares of Amazon, Facebook, General Electric, and Netflix. The Motley Fool owns shares of and recommends Amazon, Facebook, and Netflix. The Motley Fool has a disclosure policy.