9 basic principles of investing

Retirement. Most of us hope to reach that goal someday. But how will we get there? Do we depend on Social Security to support us? Are you lucky enough to still have a job with a pension? Many companies have done away with what used to be a pretty standard benefit. And if you have a pension there is always a risk when you need it, it might not be there or at least might be less than you hoped. Just ask the retired workers from Detroit.

How about college? Are you depending on loans to get Jr. through college?

Perhaps you have other long-term savings goals that you want to achieve.

What should you do with money you want to save for long-term goals? Here are several fundamental principles of investing that you should follow.

Fundamental Principles of Investingprinciples of investing

First things first

Often the best way to earn large returns is not by putting your money in the stock market but by paying off existing debt. Paying off that credit card with 18% interest is effectively the same as getting 18% on your investment. Before you consider investing, you should work hard to pay off your debt and build up a good emergency fund. Then you will be on sound financial ground and able to invest well.

When do you need the money?

If you are saving for a short-term need then you should choose a safer place for your money like a simple money market savings account or perhaps a CD depending on when you need the money. You won’t earn much interest but your money will be safe.

If are looking at longer-term goals though and have the time to ride the up’s and down’s a little bit then history says you will almost always make more money in the long run by investing in some good mutual funds.

So how do you decide what constitutes short-term vs. long-term? Most advisers generally draw this line around 5 years. The reason is we all know that the stock market can be up one day and down the next. Over an extended period though the trend is almost always upward. 5 years provides time for the market to bounce back from a more prolonged down time. History has shown that the stock market has made money for the vast majority of 5 year periods. So if you need you money in less than 5 years, it’s a bit too risky to invest it. If the market goes south you might find a good chunk of your money you were saving is gone. Put it in something safe. But if you don’t need the money for more than 5 years, investing in a good mutual fund is a great place to put your money as you have plenty of time to bounce back from any hiccups in the market and you will likely earn a lot more by taking just a little more risk.

Spread it around

Stocks related to an individual company are a huge risk. Even seemingly stable companies can have bad things happen. If you insist on investing in individual companies it should only constitute a very small percentage of your investments. A much better solution is to invest in things like a good mutual fund with a long 10 or 20 year track record of producing good returns through good times and bad. Ecclesiastes 11:2 says:

But divide your investments among many places, for you do not know what risks might lie ahead. (NLT)

Invest regularly

The best way to invest is patiently a little at a time. Proverbs 21:5 says:

Steady plodding brings prosperity, hasty speculation brings poverty (TLB)

Small regular investments made consistently over a period of many years is the path to successful investing.

Take appropriate risks

Understand how tolerant you are to risk. If the stock market has a really bad day and you know you’ll be tempted to pull all your money out then you probably should not be investing in the market. On the other hand be aware that there is a risk in being too conservative. You need to earn at least 4-6% on your investments over time or you are effectively losing money because of the effects of inflation and taxes.

Take advantage of free money

If you are fortunate to work for an employer that provides a 401(k) or similar type program and also provides a company match, take advantage of it. This is like free money. Let’s say that your employer offers to match 50% on the first 5% you put in. So if you put in $100, they will add in additional $50. In effect that amounts to an investment that is guaranteed to give you a 50% return. You won’t beat that anywhere.

The only time I would forgo taking advantage of this would be for a very short time if you were intensely focused on getting out of debt or if you are facing a severe financial crisis like a foreclosure or bankruptcy.

Don’t invest in what you don’t understand

Never invest in something you couldn’t explain to a friend. People end up losing their life savings when they invest in things they do not understand. If you do not know where to get started, find a trusted adviser that can help you. The key is you want to find an adviser that is willing to teach not an adviser that is only interested in selling. If they are unable or unwilling to patiently explain their advice until you understand, then that is a sign you need a new adviser.

Your best friend

Your best friend when it comes to investing is time. If you are young and reading this please take this to heart. The sooner you start the easier it is to accumulate a nice nest egg. For example if you wanted to be a millionaire at age 65 assuming the market averaged 10%, if you started at age 20 you’d only need to invest $106 a month. Wait just ten years and start at age 30? Now you need to invest $280 a month to reach the same goal. Wait 10 more years and at age 40, you would need to invest $771 a month.

If you are already older and never started I don’t want to discourage you. There is no bad time to get started. There is an old saying that the best time to plant an oak tree is 20 years ago. The second best time is today. So it’s never too late to start.

Keep it simple

Lastly, I would say keep things simple. Most millionaire next door types do not have complicated investments. It is a myth that the path to success requires a series of complicated investment strategies that can only be understood by someone with a Harvard MBA. The path most millionaires have followed to wealth is very simple. Spend less than you make. Be diligent about putting away a little bit of the surplus each month. Put your money in a few solid investments that have long track records of success and are spread across a wide variety of industries, localities, and types of companies. Never invest in anything you don’t understand. Continue to follow those strategies over a long period of time.

What long-term goals are you investing for?

Photo credit: StockMonkeys.com (creative commons)

 

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