Investing can seem daunting to newbies, but it doesn’t have to be! In fact, investing could just be the difference between retiring comfortably and being financially destitute in your old age. In this investing 101 guide, we’ll go over everything you need to know about how to save and invest your money so that it works hard for you in the future instead of burning a hole in your pocket now.
Investment Options
There are a lot of options out there when it comes to investments, but most people stick to just a few. You may have heard that diversification is key—and it is! Investing in only one thing is risky because you’re putting all your eggs in one basket. It doesn’t help if something bad happens to that company or they start doing poorly. To be properly diversified, an investor needs to spread their assets around so they can weather any storm. Diversification isn’t just about what companies you choose, either; it extends to how you choose them too! If you invest in stocks with your brokerage account, don’t put all of your money into 10 stocks. By spreading your funds across a number of different companies and industries, you reduce risk. Each industry has its ups and downs and although some do better than others during certain times of year, no one knows exactly which will excel at any given time. By spreading your funds around at least 15-20 different entities, you maximize your chances of seeing growth on some level year over year. The same goes for bonds: diversify both by type (short term vs long term) and by issuer (corporate vs government). Even real estate investments call for proper diversification: avoid properties in floodplains and high crime areas and rent out multiple properties rather than owning more than two or three outright.
Common Investment Mistakes
Many people fail to get started investing because they’re worried about making mistakes. But there are some common errors that anyone can avoid to help them get started. Here are four of them, plus how to avoid each one:
1) Doing nothing: If you don’t start investing immediately, it’s likely you won’t invest at all. The longer you wait, generally speaking, the less time your money has to grow and compound over time. If that $1,000 becomes $10,000 over 50 years by earning 7% annually (not exactly realistic but illustrative), it will be worth $1 million if left untouched. Unfortunately, many investors let their savings languish in low-return investments like cash or cash equivalents because they lack patience. Don’t make their mistake—start investing now.
2) Relying on high returns to compensate for high risk: Not understanding risk is probably what prevents most investors from starting sooner rather than later. Investing entails making bets on an uncertain future, so coming up with a plan for dealing with uncertainty is crucial. In general, high risk tends to mean high reward, as long as enough opportunities come along where you can buy stocks inexpensively compared to their long-term outlook. That means being able to weather a down market without getting rattled into selling good stocks just because their price dropped substantially one day – a mistake known as panic selling. Fortunately, young investors have a lot of time before retirement – typically decades – which gives them plenty of opportunities for smart reinvestment when something does go wrong.
3) Selling after short periods of success: Individual stocks almost always fluctuate in value from day to day and week to week based on company news and investor perceptions about future prospects. Investors can profit by buying stocks when they’re undervalued and then holding onto them until share prices rise again. However, many novice investors panic when prices fall shortly after buying into a stock and sell out early to cut their losses. Even worse is not learning from such experiences and repeating similar mistakes over and over again. A better approach would be diversifying your portfolio across different industries, sectors or geographic areas; having only one stock tied closely to the fortunes of any single firm makes rebalancing much harder when things do go wrong.
4) Trying too hard: Research shows that trying hard often leads to poor performance instead of improved results—and diversification plays a key role here too. Following hot investment trends can lead to chasing them, which can lead to buying high and selling low. For example, investing heavily in internet stocks during their boom of 1996 through 2000 led to massive losses for investors who bought at bubble levels and had no way of knowing when it was time to scale back. On the other hand, holding a very diversified portfolio reduces individual stock impact. This results in lower expected returns since higher returns are more easily achieved when investors are concentrating their capital, but also lowers overall volatility because bad results for one sector or asset class don’t hurt nearly as much when everything else is going well. If you want more help beyond what’s covered here, consider seeking professional financial advice.
How Much Should I Save?
To figure out how much you should be saving each month, start by thinking about how much money you’ll need to live comfortably in retirement. Experts say you should plan on needing 80 percent of your current salary or more to maintain your lifestyle once you stop working. The easiest way to set that goal is simply to multiply your current salary by 20—that gives you a rough idea of what type of income level will sustain your standard of living in retirement. Another less precise method is to take 10 percent of your income and put it into savings every month. Whatever number you decide on, just make sure it’s realistic so you don’t get discouraged along the way! Then once you know how much money you want coming in during retirement, subtract any debts (student loans, credit card bills) and expenses (mortgage/rent payments) from that number.
Asset Allocation
Before you can determine which types of investments are right for you, it’s important to take stock of your overall financial picture. This means creating a pie chart that shows what kinds of assets make up your portfolio, including real estate, bank accounts and other investments. Asset allocation is essentially how much of each asset class—such as stocks or bonds—you choose to include in your portfolio. For instance, if your portfolio consists mainly of stocks, you have a high equity allocation. If most of your money is tied up in cash and bonds, then your equity allocation is relatively low.
How should you divvy up your portfolio? If you’re investing for short-term goals, such as saving up a down payment on a house or car, then asset allocation is less important than just putting all your money in low-risk investments. However, if you’re investing long term or building wealth that you plan to leave to future generations, then it pays to be more strategic about how you divide up your portfolio between growth and income. You may want 80% of your assets in equities (stocks) that are likely to grow over time with 20% sitting in cash or other liquid assets so you can have ready access to cash when needed. Or perhaps 60/40 makes sense to you—meaning 60% equities and 40% fixed income—as an easy way of achieving some balance.
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