Although it’s tempting to think that our time in history is somehow different and we need to alter the way we invest our money, solid investing principles never go out of style. Reading comments made both before and after the Great Depression from 80+ years ago sounds like many investors today.
Before: “We’re in a new era of investing and things couldn’t be better” or “This market has tremendous staying power for the long term.”
After: “I lost everything and I’ll never put my money into the stock market ever again” or “Investing in the stock market is like gambling your money away.”
Despite the call for different investing principles, strategies, or tactics, we really should step away and think about the bigger picture. Solid investing principles are still logical, effective, and legitimate. Some people DO need to reassess their personal risk tolerance, need to start a savings account instead of a brokerage account, or even (gasp!) cut back on their discretionary spending, but the following investing principles are time-tested guidelines that you and I can follow in any market and expect relative success:
- Don’t even try to time the market:The markets are counter-intuitive and savvy investors know it. That’s why Warren Buffet says to “buy when others are fearful and sell when others are greedy.” It is SO difficult to do that though. So. Very. Difficult.
- Utilize dollar cost averaging:Set aside a fixed dollar amount every month for investing regardless of what the market does and purchase your securities the same day every month. You’ll buy more shares when prices are low and fewer shares when prices are high. Dollar cost averaging helps you mitigate market risk by eliminating the guesswork of what the stock market is going to do tomorrow.
- Keep a minimum of 3 to 6 months of expenses in your emergency fund:In difficult financial times or when you become suddenly unemployed, you won’t regret it. Unless you have a very secure and stable job, I recommend a 6 month emergency fund.
- Don’t invest in anything you don’t fully understand: And don’t try to fool yourself into thinking you understand it, either. If you just can’t get your head around an investing idea after it’s been explained or after you’ve done a reasonable amount of research, don’t invest in it.
- Don’t chase a hot stocks, funds, or asset classes:Today emerging market funds may be skyrocketing but tomorrow it could be small cap domestic exchange traded funds. Remember the dot-com bubble? It shocked a lot of people who know a lot more than you or I do about investing.
- Diversify:Each investor needs a diversified mix of fixed income and equity investments consistent with their unique investment goals and objectives. Depending on your personal level of risk tolerance, a portion of your portfolio should be in commodities and real estate.
- Don’t make emotional investing decisions: Fear and greed have trapped many investors. Don’t make rash decisions based on your emotions. They change and they change often, right? (be honest) And don’t forget that the stock market is counter-intuitive.
- Never put more than 5% of your portfolio into any one stock or security: As we have seen with many firms over the last few years, any company can go belly-up. Lehman Brothers, Enron, Washington Mutual, Polaroid, Countrywide Financial. To lessen this type of risk, I would recommend the exchange traded funds or mutual funds over individual stocks. If you decide to invest in an individual stock, never put too much faith in one company.
- Never ignore the tax implications:Some investment vehicles have better tax advantages than others such as Roth IRAs or 401k plans. Always know the tax implications when buying or selling any security in your portfolio.
- Know your fees and surrender charges on each investment: When you’re deciding on which investments you’ll buy for your portfolio, always be fully aware of any fees and/or commissions. And always be cautious with any investment that has a “contingent deferred sales charge.” Many people have discovered too late that selling or transferring a previously purchased investment (usually annuities), has a 5-10% surrender charge if they sell within the first 10 years. That surrender charge can have a major impact on your flexibility. Always try to buy securities with low fees and no surrender charges.
What major investing principle would you add to this list?