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 investments for a portfolio.
A little education can go a long way toward making you feel more comfortable in your investing decisions, though. Following are eight fundamentals that will get beginning investors started.
1. Savings erode if you’re not investing
If your money isn’t growing, it is losing purchasing power to inflation, the rising of prices over time. For instance, you’d need $300.52 in October 2018 to buy the same stuff you could get for $100 in October 1980, according to the U.S. 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 the full value over time.
2. 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 of 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 approaches. Money Talks News founder Stacy 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. Stacy suggests dividing the rest of your savings in half, investing one half in a low-cost intermediate bond fund and the other half in a high-yield savings account that is FDIC-insured. You can find the best rates by visiting our Solutions Center.
3. Don’t try picking stocks
Purchasing stock in individual companies is risky for beginners — and arguably other investors as well. If you invest in a company that ends up going bankrupt, there goes however much money you invested.
Instead of buying individual stocks, buy shares of mutual funds that invest in many companies. That way, you lower the investment risk by distributing it more broadly — an investment strategy technically known as diversification.
The chief advantage of a mutual fund is that it allows an investor to own a small slice of a big portfolio. Diversifying with a bunch of stocks or bonds is much safer than putting all your money into one or two stocks or bonds.
4. Choose index funds
There are two main types of mutual funds in terms of how they are managed:
- Actively managed mutual funds, or active funds, are run by financial professionals who decide which individual stocks or bonds to buy and sell within the fund. They aim to outperform financial market indices.
- Passively managed mutual funds, also known as index funds, simply aim to mirror a stock market index such as the S&P 500.
Research shows that index funds generally outperform managed funds while charging lower fees.
5. Keep fees low
How much you pay in fees can make a big difference. Consider this example from “Of All the Fees You Pay, This Is the Worst“:
Say you have a 401(k) with a current balance of $25,000. And over the next 35 years, you earn an average return of 7 percent on that balance. Even if you don’t contribute another penny to your account during those 35 years, here’s how much money you’d have if your account fees were 0.5 percent, compared with if they were 1.5 percent:
|Beginning balance||Annual return||Fees||Balance in 35 years|
So, the higher fees cost you an additional $64,000 over 35 years.
You can do better with index funds — again, one of their big advantages is that they tend to be cheaper than actively managed funds.
6. Expect market declines
It can be scary to see your savings plummet in value in a market downturn. Often, the impulse is to pull your money out of the stock market and stay out, as many investors did during the Great Recession.
But such investors missed out on the gains that followed. It took a few years, but the market eventually recovered and pushed on to new highs.
7. 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, too. If you are forced to borrow from investments, you might suffer penalties and fall behind on your retirement savings goals.
8. There’s no need to go it alone
You can learn through your mistakes, but it’s simpler and cheaper to learn from others. So, consider hiring a financial planner.
You can also read investing books. Three classics are:
- “The Little Book of Common Sense Investing” by John C. Bogle
- “A Random Walk Down Wall Street” by Burton G. Malkiel
- “The Intelligent Investor” by Benjamin Graham and updated by Jason Zweig
If you prefer to read online, check out “Build a Successful Retirement Plan With These 5 Steps.”
What do you think beginning investors need to know? Share your thoughts below or on our Facebook page.