Don’t Invest Until You Learn These Rules!
Saving Money is a Prerequisite to Investing. Unless you win the lottery or had a wealthy uncle who left you a lot of money, living within your means and disciplining yourself to regularly set money aside is the cornerstone to successful investing & wealth building.
In addition – I recommend not tying your money up in a long-term investment such a rental real estate or qualified retirement plans until you have adequate savings. What’s the sense of overextending yourself and an emergency happens? You may have to liquidate that investment quickly, at a loss, and/or pay taxes and penalties. My recommendation: save first, then invest.
- Never Make an Investment Without Knowing the End Game. Many people begin contributing money to their 401k without realizing that money is locked up until they are 59 & ½ years old. It can be very cumbersome to access that money – say, in 5 years’ time – to pay for a wedding.
If you’re investing in stocks, and it’s for a short-term investment – what’s the end game? Most likely, you’ll never time it perfectly and get out when it’s at its absolute zenith. So, when are you going to sell? When it hits a certain price? When you achieve a certain % gain? Develop your exit strategy before ever making the purchase.
- Proper Allocation of Assets. Understand the use for each “Bucket” of money in your financial plan, and position that money in the proper savings or investment vehicle. Your 401k and Roth IRA are earmarked for retirement, which may be many years into the future. With this bucket of money, we have a much longer time horizon and can afford to take on more risk with growth-oriented investments strategies.
On the other hand, if you’re saving money for a down payment on a house just a few short years from now, that “bucket” of money should be positioned in a vehicle with consideration to liquidity & risk, based on the shorter time horizon.
- Know the 3 Best Wealth-Building Investments. Historically, people have grown their wealth via “ownership assets” – stocks, real estate, and small business – where they share in the success & profitability of that asset.
- Think Long Term for Building Wealth. Because Ownership Investments are riskier (more volatile) in the short term, you must keep a long-term perspective when investing in them. Don’t invest money into these vehicles if you plan to hold them for less than 5 years (I call that “speculating,” not investing). I prefer the time period to be 10 years or longer.
- Do Your Homework. You work hard for your money. Buying and selling investments cost you money. Investing isn’t an area where it’s ever okay to make knee-jerk decisions and then ask questions later. Never buy investments based on emotions, a fancy advertisement, or what the herd is doing. The reason they’re in a herd is because they’re on the way to slaughter.
- Diversify. Diversification can be a powerful tool to help reduce risk when you’re holding more aggressive investments. Diversifying means holding a variety of investments & asset classes that don’t move in tandem in different market environments. For example, if you’re investing in stock mutual funds, you may want exposure to funds that are heavily weighted in the information technology sector like the NASDAQ, but you may also want exposure to the broader U.S. Stock Market, such as the S & P 500.
In addition to these Large Cap Stocks, you may want to have exposure to Mid-Caps & Small Caps as well; and you may want to diversify further by investing worldwide, not just in the U.S. markets. Internationally, there are developed markets and emerging markets that one may choose to invest in. If desired, one could own a piece of all of those different sectors, and more!
- Consider Owning Non-Correlated Asset Classes. These are assets that don’t move in lockstep with the direction of the financial markets, and can offer you increased diversification, additional protection, or increased upside potential (sometimes all).
These include assets such as insurance products (cash value life insurance or annuities); precious metals (physical or ETFs); cryptocurrencies (Bitcoin, Ethereum, etc.), and you can further diversify your portfolio by owning real estate (or investing in a Real Estate Investment Trust, or REIT, if ownership of physical property isn’t practical for you).
Ignore the Noise. Don’t feel mystified by or feel the need to follow the short-term variations in the financial markets. Checking the performance of your investments every day – especially those that are considered long term – can be a quick way to bring about anxiety and misery… and that can lead to bad investment decisions.
Ultimately, the prices of stocks, bonds, and other financial assets are largely determined by supply and demand, which can be influenced by hundreds of external factors, plus the expectations and fears of millions of investors worldwide.
- Know the History. Short-term returns can be extremely volatile and unreliable. For instance, the inflation-adjusted true rate of return of the S & P 500 from Jan 1980 – Jan 2000 was 9.303% (and nearly 13% if reinvesting dividends). This time period was marked by a tremendous economic boom and widespread implementation of the internet & other technology.
Conversely, the next 20-year block, from January 2000 – Jan 2020 saw an inflation-adjusted true return of just 2.064% (4.012% if reinvesting dividends). This time period was marked by 2 separate stock market crashes of 50%, including the financial crisis of 2008, and a real estate market meltdown. Now 2010-2020 saw the best bull market run in U.S. History, but it still wasn’t enough to make up for the tremendous losses of 2000-2010.
Source: https://dqydj.com/sp-500-return-calculator/
- Be Realistic About Your Expectations. As seen above, markets can be unreliable and unpredictable in the short term. However, as history has shown us, the more time you allot to your investment horizon, the more risk you take off the table, and the more likely it is that you’ll achieve solid returns. The market tends to trend up – if you give yourself enough time.
During the 40-year period of Jan 1980-Jan 2020, the true ROR was 5.622% (8.398% if reinvesting dividends). When making projections, my advice is to be conservative and use 6-8%. If you end up averaging 9 or 10%, you’ll be extremely happy with the end result, as you’ll wind up with more money than you planned on. That’s much better than the alternative, winding up with less money than you need because your expectations were too rosy.
- The Less You Know About Taxes, the More Taxes You’ll Pay. Taxes are the greatest expense that we’ll have in life, and it can demolish your investing results. Understand the ramifications of the decisions you make with your qualified retirement plans, as well as the impact of your tax bracket when investing outside these tax-sheltered retirement accounts.
- Minimize Your Trading. The more you trade, the more likely you are to make mistakes. The more you trade, the more you get hit with increased transaction costs, which erode your investment performance; and you also get hit with higher taxes, with further erodes investment performance (the tax statement applies to non-retirement accounts).
- Ignore the Influencers and Talking Heads. These people are wrong much more often than they are right. Predicting the future is nearly impossible. Select and hold good investments, based on a long-term strategy that fits your financial philosophy and personal goals. Don’t try to time when to get in or out of a particular investment based on a quick snippet you see on a news channel or YouTube.
- Don’t Expect to Beat the Market. If you have the right skills and interest, your ability to do “better than the average” is almost always greater in real estate and/or owning a small business than it is with stock market investing. Why? Because you have much greater personal control in those avenues.
The large number of experienced, full-time stock market professionals makes it next to impossible for you to choose individual stocks that will consistently beat a relevant market average over an extended time period. Creating a solid investment strategy and sticking to your plan is still likely to create results that you’re very happy with.
- Don’t Bail When Things Look Bleak. The hardest time, psychologically, to hold on to your investments is when the market is down. Even the best investments will go through periods of depressed values, which is the worst possible time to sell. If you bail out, you lock in your losses; if you have a long-term horizon, the market will likely recover within a few years. In fact, when these investments are “on sale,” you may want to consider buying more.
Beware What You Read and Listen To. Don’t pollute your mind with bad investment strategies, or with financial philosophies that run contrary to your core values and beliefs about money. The quality of what you read and listen to is far more important than the quantity of content you take in. Through experience, find out how to evaluate the quality of what you read and hear.
- Consider the Value of Your Time and Your Investing Skills and Desires. Real estate investing and running a small business are the most time-intensive investments. Investing in stocks and other securities via mutual funds and exchange-traded funds can be time efficient and profitable.
Finally, assess your desire to keep up with the financial markets; if you desire to do the right thing for your financial security, but do not have the desire to learn about stock market investing & financial planning in great detail, and to keep up with all the changing trends, consider working with an advisor.
- Hire Advisors Carefully. Before hiring investing help, first, educate yourself on some basic principles, so you understand your core financial philosophy, and what you want to accomplish. You want to work with someone whose values and beliefs align with yours, so synergy develops in the relationship.
Learn how to evaluate the competence of whom you may hire and beware of any conflicts of interest. A competent advisor can help you implement any of all of the items discussed here and do so in ratios that are optimal for your risk tolerance, time horizon, and risk tolerance profile.
- Your Personal Life & Health Are the Most Important Investment. What is wealth if you don’t have your health? What good is wealth if your personal relationships are crumbling? Don’t neglect the things in life that are truly important. Money isn’t the most important thing; keep it in context and make money your slave, not your master.
If you follow these 20 rules, you are likely to be very satisfied with your results. Happy Investing!
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