Beginning investors don’t realize what they don’t know. It’s all unfamiliar territory.
1. Don’t Try Picking Stocks
Purchasing individual stocks for investing is too risky for beginners, who lack the experience to predict which stocks will perform well and when to exit an investment.
Novices tend to look for stock advice in all the wrong places, says U.S. News & World Report blogger Steve Beck, co-founder of MarketRiders, an online investment management company. He wrote:
[T]he dumb money is the individual investor who watches CNBC for stock tips. It is the investor that gets a hunch, or better yet, a stock tip from a friend, and acts upon it. The dumb money is the lemming-like masses that plunge off the bluff and into the sea when despair is on tap, and double down on their investment when a sector is running hot.
Do participate in the stock market. But instead of buying individual stocks, buy shares of mutual funds that invest in many companies. That way your investing risk is less because it is distributed broadly.
2. Fire Your Fund Manager
It’s seductive to think you’ll find an ace manager who delivers terrific results.
Instead, research shows, most investors do better using unmanaged (“passive”) index funds. Index funds mimic a market index’s movements and have lower fees.
Looking at advanced portfolios holding 10 asset classes between 1997 and 2012, researchers found index fund portfolios outperformed comparable actively managed portfolios a staggering 82 percent to 90 percent of the time. And the longer investors held those investments, the better shot they had at outperforming active funds over time.
Index funds are a no-brainer for beginner investors.
3. Keep Fees Low
In 2013, The Associated Press says, the average expense ratio (operational costs) for a stock mutual fund was 0.74%, that’s $74 per $10,000 invested. But you can do even better. For instance, the Vanguard Total Stock Market Index Fund charges 0.17%.
How much you pay in fees can make a big difference. The U.S. Securities and Exchange Commission says:
For example, if you invested $10,000 in a fund that produced a 10 percent annual return before expenses and had annual operating expenses of 1.5 percent, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5 percent, then you would end up with $60,858.
4. Your Savings Erode if You’re Not Investing
If your money isn’t growing, it is losing purchasing power to inflation, the rise of prices over time. For instance, you’d need $288 in 2014 to buy the same stuff you could get for $100 in 1980, according to this Bureau of Labor Statistics inflation calculator.
Inflation has been about 3% a year or less for the past 20 years, this chart at the Federal Reserve Bank of Minneapolis shows, so your savings must earn a minimum of 3% a year just to retain their current value.
Burying cash in coffee cans in your yard is a terrible long-term investing plan. If it manages to survive the elements, it will still be worthless given enough time.
5. Don’t Put it All in Stocks
When markets are hot and your savings are growing nicely, there’s a risk, for beginning investors especially, of becoming overconfident. For example, between November 2013 and November 2014, the S&P 500 index grew more than 14%. With returns like those, it can be tempting to pour all your savings into stocks.
Don’t do it. It’s safer to spread risk among different types of investments. When the economy favors one type, others may decline, giving your portfolio a way to balance gains and losses.
To help decide how much savings to put into stocks, here are a couple rules of thumb:
- Stacy Johnson’s preferred method: Subtract your age from 100 and put that percentage of your savings into stocks (for example, put 60% of savings into stocks if you are 40, 50% if you are 50 or 40% if you are 60).
- MassResources.org, a nonprofit, suggests 30% in stocks for conservative investors, 60% if you can accept moderate risk and 80% for aggressive investors.
Divide the rest of your savings in half. Put one portion in a low-cost intermediate bond fund and the rest in a money market deposit account or other insured fund.
6. Conservatively Invest the Money You’ll Need Within 5 Years
Stock are too risky an investment for the money you’ll need as income within five years, Stacy Johnson says.
Instead, pick interest-bearing accounts or short-term investments like bonds, bond mutual funds and CDs. Choose based on the best yield you can find for the time period you need.
It’s often helpful to “bucket” assets for different time horizons, with conservative investments allocated for short-term needs, moderate investments for midterm goals (three to five years from now) and more aggressive for longer-term goals (five-plus years away).
7. Expect Market Declines
It can be scary to see your savings plummet in value in a market downturn. The impulse is to pull your money out of the stock market and stay out, as some investors did after the Dow Jones Industrial Average fell 514 points, or 5.7%, on Oct. 22, 2008.
But those investors missed out: The market eventually recovered and pushed on to new highs.
8. Don’t Let Financial Pressure Build
If you’re spending more than you make, living on credit or have no emergency fund, you are creating financial stress that can lead you to make risky investment decisions.
Financial pressure can undermine your retirement savings in other ways. If you are forced to borrow from investments or take cash out, you may suffer penalties and fall behind on savings.
9. There’s No Need to Go It Alone
Investing is a skill. It takes time and effort to read, research and find a safe but rewarding path. You can learn through your mistakes, but it’s simpler and cheaper to learn from others.
Hire a fee-only financial planner. Two places to look:
- The Garrett Planning Network, an association of fee-only planners.
- The Certified Financial Planner Board, which certifies practitioners and sets professional standards.
Read investing books. Three classics:
- The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns, by John Bogle.
- A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, by Burton G. Malkiel.
- The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel, by Benjamin Graham and updated by Jason Zweig.
- “Invest Wisely: An Introduction to Mutual Funds” is an SEC electronic publication that explains the basics of mutual fund investing, including how to avoid common mistakes.
- “Ask Stacy: How Do I Invest in a Mutual Fund?” Money Talks News founder Stacy Johnson tells a reader where and how to open a mutual fund account.
- Check out Reddit. This free online community links people with questions with investors who share their experience.
- Find investing classes at a community college. Avoid seminars and classes offered by people selling a product. You won’t get unbiased information.
- Look for classes at your workplace. Ask your human resources department.
- Read your 401(k) provider’s website. Look for articles aimed at beginning investors.
This post originally appeared on Money Talks News.
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