So here you are, on the precipice of greatness, and you have no idea how to be great.
Makes that precipice look awfully daunting, doesn’t it?
Don’t look down, only look ahead.
If you have followed basic personal finance advice so far, you are probably out of debt (other than your mortgage) and you have some level of savings set aside. You are now past survival mode, and you are now on the cusp of thriving with your money. But it doesn’t just happen.
As it has taken work and sacrifice to get to this point, it takes some effort to move to the next level. And that effort is called investing. Perhaps you have plans to retire, or to put your kids through college, or to have that big family vacation for a 50th wedding anniversary. Whatever your goal is, merely saving isn’t enough. You have to put your money to work for you, and investing is a way to do that.
Risks and Rewards of the Stock Market
While there are many different vehicles in which to invest, perhaps the vehicle that has the best track record of consistent long-term success is the stock market. And you can invest in the market through direct purchases of stock in several companies, or you can use vehicles such as ETFs (exchange-traded funds) or mutual funds. Both of which have diversified portfolios built in, with varying exposure to the different industries in the markets, or even some investments in bonds or commodities like oil, gas or gold.
When you have a time horizon of 10, 20 years or more before you would actually use the money (like, say you are retiring in 30 years, or you just had a baby and so you have 18 years before he or she heads into some kind of higher education), the stock market has had a stellar record of growing an at average rate of 8 percent per year for its history of more than 120 years.
In other words, in any 10-year period of the market, the market has always ended higher than when it started. Some individual years will be rough and others will be stratospheric, but in general the market grows at an average of 8 percent per year and it is always higher at the end of a 10-year period than at the start of it.
Crashes, depressions and recessions have been noteworthy, so there is always a risk, but the reward has been pretty reliable. Again, as long as you have a long time horizon and lots of patience.
The Rule of 72
How quickly can your money grow in the stock market when you are investing? And how fast do you want it to grow? When you are looking at what to invest in, it will be key to note the Rule of 72 which will help you understand the growth that fits what you are looking for. The Rule of 72 helps you figure out how fast your money will double within a particular investment.
For example, let’s say you found a mutual fund you like that has an annualized return of 9 percent. When you divide 72 by 9, you get 8. That means if you invest $10,000 in that mutual fund, it will take 8 years for that money to double to $20,000. If the return is 10 percent, you double your money in 7.2 years; 12 percent, 6 years, and so on.
But before you go running out to find the investment that will double your money in a year, understand that the higher the return you seek, the higher the risk. This means with more return comes the greater chance of losing money.
Let’s go briefly into the concept of what is called dollar-cost averaging in investing. Investing doesn’t have to take a lot of money – usually $500 or $1,000 is all it takes to get into a stock mutual fund, and the contributions after that can be as little as $10 or $20 at a time.
Dollar-cost averaging is just a fancy way of saying, “make a consistent contribution.” This does not take into account how the market is trending one way or the other. This is merely about contributing the same amount or something close to it at the same time during each calendar year. This can be $20 a month, $50 a quarter, and so on.
When you are ready to invest, keep this in mind – as part of your strategy (which we’ll discuss in a minute), make sure you make steady, consistent contributions whether it’s per month or per quarter or whatever you feel comfortable. What the market does should not matter to you unless you are less than 5 years away from using the money.
Now that you have these basic pieces of information, let’s get you started on how to invest for success.
Investing For Success
Step 1: Find Resources
We would never suggest you go into investing completely blind. But if you think you can simply find a few experts in the market to read, you will be surprised. The volume of “experts” available online is astounding. And it is difficult to tell which ones to rely upon.
But here is one thing to think about: Diversification. This doesn’t just apply to investing in stocks, bonds, real estate and commodities. If you are focusing solely on the stock market, you want to diversify your exposures by being involved across the entire market and not concentrate on only a couple of industry verticals.
So as you are thinking across the entire market for your investing, check out those resources that seem to address the market from a 30,000-foot view. Since you plan on being in the market for the long-term, you don’t really need too many specifics at this point, but being able to pay attention to what the market is doing now and learn about the factors that serve as catalysts for the movements of the market can help you in your decisions as you go, which will adjust as the market changes.
You can invest by yourself, but it’s always good to have some kind of financial advisor by your side to give you advice and counsel as you go along. An advisor will have his or her ear to the ground a little more and will likely have access to resources that he or she deems reliable, such as certain investor newsletters or market periodicals (think Investor’s Business Daily, The Wall Street Journal, Forbes) that they use to get a macro view of the markets.
Step 2: Know Yourself
When it comes to the market, there are several different types of investors, ranging from conservative to aggressive. While you may want to be aggressive in order to grow your money, there is also a huge risk involved. One person we know in the financial industry equates the investor as being a tick on the tail of a dog.
A more aggressive investor will be a tick on the end of the tail as it wags. It goes up and down in a very long arc. A more conservative investor will be the tick closest to the base of the tail, near the dog’s butt. When the tail wags, that part of the tail is not moving in a very big arc.
When you think of it that way, maybe you think of yourself somewhere on that dog’s tail spectrum. Do you think you can handle the natural volatility of the market and be aggressive and still hang on to the tail at the end? Or would all that volatility make you seasick?
Even with a long time horizon, some investors would rather have a little more certainty and stability in their plan. They might be willing to take a little less return for not so big drops in value.
There are some risk-tolerance questionnaires available that will help you determine where on that dog’s tail you, as a tick, would feel comfortable. Knowing that spot will form and craft your investments and your strategy.
Step 3: Build Your Plan
With that background, now you are ready to dive in. The first thing to do is to make sure you understand your goal, or the destination you are looking to achieve. And you should be specific as far as the amount of money you want to have and the time horizon.
For example, you are investing in order to retire with a $1 million nest egg in 30 years. That is your destination, and now you need to know where you are starting. In other words, how much money can you invest now, and how much can you contribute along the way (the dollar-cost averaging mentioned before)?
When you talk with your advisor about this goal and your current situation, he or she can help you draw out the map that you’ll follow to get to that destination, including what to invest in and how much to invest (maybe you have to invest more up front, or contribute more along the way).
Step 4: Make a Strategy
Now that you know your risk tolerance, your horizon, and your vehicle (mutual fund or straight stock purchases), you are ready to implement your plan, or your road map, by getting in the car and driving.
You can work with your advisor to develop your strategy. What to invest in, how much to invest, and take an approach of how long to go with the strategy you create. Do you take this path for a year, five years, 10 years? What circumstances may dictate a change or detour on the path?
Choose your vehicle to drive, make the investment and drive the path set before you.
Step 5: Rebalance
As part of the strategy, you should set up an opportunity to review your investment and rebalance it. Generally every year is recommended, though you could do it more or less often depending on your plan and strategy.
Rebalancing is just to make sure you reset your investments so they are diversified the way you started at the beginning of the year. For example, if you started the year invested 25 percent in each of four different mutual funds, at the end of the year you may have 27 percent of your portfolio in one fund, 25 percent in another, 28 in another and 20 percent in the fourth.
When you re-balance, you buy and sell the pieces in the funds so that you return to 25 percent in each of the four funds. Rebalancing is based on the principle of “buy low, sell high.” Those funds that were successful in the past year, you sell the profits and reinvest them in the fund(s) that didn’t do so well.
Whatever your strategy is, the goal is to make sure you stick to your strategy every year until some predetermined circumstance dictates a change is necessary.
Following this path is the best, most reliable way to ensure investment success over the long term. Get in the market, even as it’s on its peak, and don’t pull all the way out just because the market crashes.
In fact, be contrary, as Warren Buffett has said, and stick to the “buy low, sell high” mantra. When the market crashes, step up your investments. When it reaches peaks, sell off some pieces and re-invest them.
To have success in investing, it takes patience, and seizing opportunities when they arise. The tortoise always wins.