Investing Basics - Principles of Investing
- 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.
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.
