Beginning investors don’t realize what they don’t know. It’s all unfamiliar territory, so it is natural to feel a bit unsure about selecting and maintaining a portfolio.
Following are nine information tidbits that can get you started.
1. Don’t try picking stocks
Purchasing individual stocks for investing is too risky for beginners, who lack the experience to predict which stocks will perform well and when to exit an investment.
Novices tend to look for stock advice in all the wrong places. Instead of buying individual stocks, buy shares of mutual funds that invest in many companies. That way, you lower investment risk by distributing it more broadly.
2. Fire your fund manager
It’s seductive to think you’ll find an ace manager who delivers terrific results.
Instead, research shows that most investors do better using unmanaged — or “passive” — index funds. Index funds mimic a market index’s movements and have lower fees. As Money Talks News founder Stacy Johnson writes:
There’s a mountain of evidence suggesting market timing is tough. For example, despite the fact that mutual funds employ both the smartest people and best technology on the planet, the average professionally managed mutual fund underperforms a simple, unmanaged index.
Index funds are a no-brainer for beginner investors.
3. Keep fees low
How much you pay in fees can make a big difference. The U.S. Securities and Exchange Commission says:
For example, if you invested $10,000 in a fund that produced a 10 percent annual return before expenses and had annual operating expenses of 1.5 percent, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5 percent, then you would end up with $60,858.
Morningstar‘s 2015 fee study found that the average asset-weighted expense ratio across all funds was 0.64 percent. But you can do even better. For instance, the Vanguard Total Stock Market Index Fund charges a mere 0.16.
4. Savings erode if you’re not investing
If your money isn’t growing, it is losing purchasing power to inflation, the rise of prices over time. For instance, you’d need $293 in 2016 to buy the same stuff you could get for $100 in 1980, according to this Bureau of Labor Statistics inflation calculator.
The Federal Reserve has a goal of maintaining a 2 percent inflation rate. If the Fed is successful, your savings must earn a minimum of 2 percent a year just to retain their full value over time.
5. Don’t put it all in stocks
When markets are hot and your savings are growing nicely, there’s a risk — especially for beginning investors — of becoming overconfident. When returns are great, it’s tempting to pour all your savings into stocks.
Don’t do it. It’s safer to spread risk among different types of investments. When one type of investment sinks, other types may rise, giving your portfolio a way to balance gains and losses.
How much of your savings should be invested in stocks? There are many different possible approaches, but Johnson suggests you subtract your age from 100, and put the difference as a percentage of your savings into stocks. For example, keep the following percentages of savings in stocks:
- 60 percent if you are 40
- 50 percent if you are 50
- 40 percent if you are 60
What should you do with the rest of your money? Again, opinions vary. One suggestion is to divide the rest of your savings in half. Put one half in a low-cost intermediate bond fund and the other half in a money market deposit account or other insured fund.
6. Invest some money conservatively
Stocks are too risky an investment for the money you’ll need as income within five years, Johnson says.
Instead, pick interest-bearing accounts or short-term investments such as bonds, bond mutual funds and CDs. Choose based on the best yield you can find for the time period you need.
7. Expect market declines
It can be scary to see your savings plummet in value in a market downturn. The impulse is to pull your money out of the stock market and stay out, as some investors did after the Dow Jones Industrial Average fell 514 points, or 5.7 percent, on a single day — Oct. 22, 2008.
But such investors missed out. It took a few years, but the market eventually recovered and pushed on to new highs.
8. Don’t let financial pressure build
If you’re spending more than you make, living on credit or have no emergency fund, you are creating financial stress that can lead you to make risky investment decisions.
Financial pressure can undermine your retirement savings in other ways. If you are forced to borrow from investments or take out cash, you might suffer penalties and fall behind on savings.
9. There’s no need to go it alone
Investing is a new skill. It takes time and effort to read, research and find a safe but rewarding path. You can learn through your mistakes, but it’s simpler and cheaper to learn from others.
Consider hiring a financial planner. For tips, read the article “How to Find the Right Financial Adviser.” Two places to look for a planner are:
- The Garrett Planning Network, an association of fee-only planners
- The Certified Financial Planner Board, which certifies practitioners and sets professional standards
You can also read investing books. Three classics are:
- “The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns,” by John Bogle
- “A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing,” by Burton G. Malkiel
- “The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel,” by Benjamin Graham and updated by Jason Zweig
If you prefer to read online, check out:
- “Invest Wisely: An Introduction to Mutual Funds“
- “Ask Stacy: How Do I Invest in a Mutual Fund?“
- “A Simple Way to Invest Your Retirement Savings“
Finally, consider any of the following:
- Find investing classes at a community college. Avoid seminars and classes offered by people selling a product. You won’t get unbiased information.
- Look for classes at your workplace. Ask your human resources department.
- Read your 401(k) provider’s website. Look for articles aimed at beginning investors.
What do you think beginning investors need to know? Share your thoughts below or on our Facebook page.