Investing Basics - Principles of Investing

1. Start Investing

Now We say this not just to discourage procrastination, but because an early start canmake all the difference. In general, every six years you wait doubles therequired monthly savings to reach the same level of retirement income. Another motivational statistic: If you contributed some amount each month for thenext nine years, and then nothing afterwards, or if you contributed nothing for the firstnine years, then contributed the same amount each month for the next 41 years, you wouldhave about the same amount. Compounding is a beautiful thing.

2. Know Thyself

The right course of action depends on your current situation, your future goals,and your personality. If you don't take a close look at these, and make them explicit,you might be headed in the wrong direction.

• Current Situation: How healthy are you, financially? What's your net worth right now?What's your monthly income? What are your expenses (and where could they be reduced)?How much debt are you carrying? At what rate of interest? How much are you saving?How are you investing it? What are your returns? What are your expenses?
• Goals: What are your financial goals? How much will you need to achieve them?Are you on the right track?
• Risk Tolerance: How much risk are you willing and able to accept inpursuit of your objectives? The appropriate level of risk is determined by yourpersonality, age, job security, health, net worth, amount of cash you have to coveremergencies, and the length of your investing horizon.

3. Get Your Financial House In Order

Even though investing may be more fun than personal finance,it makes more sense to get started on them in the reverse order.If you don't know where the money goes each month, you shouldn't be thinking aboutinvesting yet. Tracking your spending habits is the first step toward improving them.

If you're carrying debt at a high rate of interest (especially credit card debt),you should unburden yourself before you begin investing. If you don't know how muchyou save each month and how much you'll need to save to reach your goals, there'sno way to know what investments are right for you.

If you've transitioned from a debt situation to apaycheck-to-paycheck situation to a saving some money every month situation,you're ready to begin investing what you save. You should start by amassing enough tocover three to six months of expenses, and keep this money in a very safe investmentlike a money market account, so you're prepared in the event of an emergency. Once you've saved up this emergency reserve, you can progress to higher risk(and higher return) investments: bonds for money that you expect to need in the nextfew years, and stocks or stock mutual funds for the rest. Use dollar cost averaging,by investing about the same amount each month. This is always a good idea,but even more so with the dramatic fluctuations in the market in the past 10 years.Dollar cost averaging will make it easier to stomach the inevitable dips.

And remember, never invest in anything you don't understand.

4. Develop A Long Term Plan

Now that you know your current situation, goals, and personality,you should have a pretty good idea of what your long term plan should be. It shoulddetail where the money will go: cars, houses, college, retirement. It shouldalso detail where the money will come from. Hopefully the numbers will be about the same.

Don't try to time the market. Get in and stay in. We don't know what directionthe next 10% move will be, but we do know what direction the next100% move will be.

Review your plan periodically, and whenever your needs or circumstanceschange. If you are not confident that your plan makes sense, talk to an investmentadvisor or someone you trust.

5. Buy Stocks

Now that you've got a long term view, you can more safely invest in 'riskier' investments, which the market rewards (in general). This requires patience and discipline, but it increases returns. This approach reduces the entire universe of investment vehicles to two choices: stocks and stock mutual funds. In the long run, they're the winners: In this century, stocks beat bonds 8 out of 9 decades, and they're well in the lead again. According to Ibbotson's Stocks, Bonds, Bills and Inflation 1995 Yearbook, here are the average annual returns from 1926 to 1994 (before inflation):

• Stocks: 10.2% (and small company stocks were 12.1%)
• Intermediate term treasury bonds: 5.1%
• 30-day T-bills: 3.7%

But is it really worth the additional risk just for a few percentage points?The answer is yes. 10% a year for 20 years is 570%, but 7% a year for 20 yearsis only 280%. Compounding is God's gift to long term planners.

If you buy outstanding companies, and hold them through the market's gyrations,you will be rewarded. If you aren't good at selecting stocks, select some mutual funds.If you aren't good at selecting mutual funds, go with an index fund(like the Vanguard S&P 500).

6. Investigate Before You Invest

Always do your homework. The more you know, the better off you are. This requires that you keep learning, and pay attention to events that might affect you. Understand personal finance matters that could affect you (for example, proposed tax changes). Understand how each of your investments fits in with the rest of your portfolio andwith your overall strategy. Understand the risks associated with each investment. Gather unbiased, objective information. Get a second opinion, a third opinion, etc. Be cautious when evaluating the advice of anyone with a vested interest.

If you're going to invest in stocks, learn as much as you can about the companiesyou're considering. Understand before you invest. Research, research, research.Read books. Consider joining an invesment club or an organization like the AmericanAssociation of Individual Investors . Experiment with variousstrategies before you put your own money on the line. Examine historical data orparticipate in a stock market simulation. Try a momentum portfolio, a technicalanalysis portfolio, a bottom fisher portfolio, a dividend portfolio,a price/earnings growth portfolio, an intuition portfolio, a megatrends portfolio,and any others you think of. In the process you'll find out which ones work best for you.Learn from your own mistakes, and learn from the mistakes of others.

If you don't have time for all this work, consider mutual funds, especially index funds.

7. Develop The Right Attitude

The following personality traits will help you achieve financial success:

• Discipline: Develop a plan, and stick with it. As you continue to learn,you'll become more confident that you're on the right track. Alter your assetallocation based on changes in your personal situation, not because of some shortterm market fluctuation.
• Confidence: Let your intelligence, not your emotions, make your decisions for you.Understand that you will make mistakes and take losses; even the best investors do.Re-evaluate your strategy from time to time, but don't second-guess it.
• Patience: Don't let your emotions be ruled by today's performance.In most cases, you shouldn't even be watching the day-to-day performance, unless you like to.Also, don't ever feel like it's now or never; don't be pressured into an investment you don'tyet understand or feel comfortable with.

The following personality traits will hurt your chances of financial success:

• Fear. If you are unwilling to take any risk, you will be stuck with investmentsthat barely beat inflation.
• Greed. As an investment class, 'get rich quick' schemes have the worst returns.If your expectations are unrealistically high, you'll go for the big scores, which usuallydon't work.

It is generally a good idea to avoid making financial decisions based on emotional factors.

8. Get Help If You Need It

The do-it-yourself approach isn't for everyone. If you try it and it's not working, or you're afraid to try it at all, or you just don't have the time or desire, there's nothing wrong with seeking professional assistance.

If you want others to handle your financial affairs for you, you will nevertheless want to remain involved to some degree, to make sure your money is being spent wisely.