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Are you thinking about investing for the first time? Whether you’re a newly minted college graduate or a late starter in her 50s, the task of plunging into the stock market can feel daunting.
While I’m sure there are courses designed to get you up to speed as a stock investor, I’m going to tell you a lot of what you need to know in this short article. The good news is that investing in the stock market looks way more complicated than it actually is.
But you’ll only do well if you avoid some key mistakes. Here are five blunders that can sink your chances of getting solid returns over your investing lifetime.
Mistake No. 1: Buying stocks with money you’ll need soon
When it comes to stocks, the longer your investment horizon, the lower the risk. By contrast, taking a short-term approach — such as day trading or holding stocks for very short amounts of time — is exceedingly risky, because nobody knows what’s going to happen at any given hour or day.
Investing over decades carries far less risk because quality companies become more valuable over time, and so do their shares. That’s why you should never invest in stocks with money you will need within five years, minimum.
Mistake No. 2: Going “all in” instead of using moderation
Because the stock market is risky, it’s not the basket for all your eggs. Here’s the formula I’ve suggested countless times over the years: Start by subtracting your age from 100, then put no more than the resulting figure as a percentage of your long-term savings into stocks.
So if you’re 25, 100 minus 25 equals 75 percent in stocks. If you’re 75, you’d only use stocks for 25 percent of your savings. Important: That’s just a rule of thumb. If you use the rule but still feel nervous, you’ve invested too much.
Mistake No. 3: Investing in individual stocks instead of mutual funds
I like buying individual stocks, but it’s not necessary. For most people, it’s not even advisable. You can do perfectly well with a mutual fund, while at the same time lowering your risk and reducing your hassle.
What’s a mutual fund? It’s a giant pool of investments. It could be a pool of stocks — a stock fund. It could be a pool of bonds — a bond fund. Or it could have both stocks and bonds — a balanced fund.
The appeal of mutual funds is threefold:
- A mutual fund allows you to spread the inherent risk of stock investing by diversifying among a bunch of stocks instead of investing in just a few.
- Mutual funds have professionals who do the buying and selling.
- Mutual funds keep track of a lot of the paperwork for you.
The stock mutual fund that I personally use in my retirement account is one of the lowest-cost, and most popular, funds in the world: Vanguard 500 Index Fund. Here’s the way Vanguard describes it:
The fund offers exposure to 500 of the largest U.S. companies, which span many different industries and account for about three-fourths of the U.S. stock market’s value.
Doesn’t that sound like it fits the bill nicely? Funds like this are a simple way to own a slice of the American economy. And the cost? On this fund, it’s less than 0.2 percent per year, which is way less than most funds charge. The minimum investment is $3,000.
This isn’t a commercial for Vanguard funds, just some insight into how I happened to make the choice. But it’s not the only option. Growing in popularity, and equally good, is the exchange traded fund, or ETF. This type of investment is similar to traditional mutual funds, but it trades on exchanges, just as stocks do.
Mistake No. 4: Trying to time the market
Yes, we’d all love to buy at the bottom and sell at the top. But none of us are smart enough to do it consistently.
Try to time the market, and you’ll likely find yourself on the sidelines when the market takes off and overinvested when it crashes. The best way to approach stock investing is also the simplest — dollar-cost averaging, also known as systematic investing. All you have to do is invest fixed amounts, like $100, at regular intervals, such as monthly.
This method works for a simple reason: It automatically leads you to buy more shares when they’re cheap and fewer when they’re not.