Most conversations on how to invest focus on methods of investing. An experienced investor will tell you that there’s no magic formula. This lesson has usually been learned the hard way. There are some time proven concepts that won’t, by themselves, assure success, but can help reduce some of the risk associated with investing.
• Have a plan – Most people spend more time planning their weekends than planning for their financial future. There’s more to investing than just picking stocks. You need a plan with clear goals and well defined objectives.
• Timing the market – Waiting for the right time to buy or sell can be a long wait. Timing the market is virtually impossible. Expert after expert has concluded that this is not an exact science. There’s really no way to tell exactly where the bottom is or where the top is. Staying investing and riding out the ups and downs is one time proven way to benefit. Trying to time the market can be one of the costliest errors.
• Avoid taxes legally – Most people don’t take advantage of all the legitimate instruments available to defer and avoid taxes. Deferring taxes can add, in many cases, 31 percent to your principal, and can significantly accelerate portfolio growth. Have you considered Tax-Free Bonds, a SEP-IRA, a Salary Deferral Plan, an IRA or a 401(K)? Take the time to review all your options.
• Unnecessary risk – Some people try to obtain such a high return that they dramatically increase the chance of losing much of their initial investment. Others are over conservative and their buying power is eroded over time by inflation and taxes and because they wanted a guarantee of principal rather than working towards preserving their purchasing power. CD’s and money markets are fine when they are used in the proper percentage and at the proper time. However, leaving all or most of your portfolio in similar cash investments can be like dying a slow financial death. You just can’t counter the effects of inflation when your money is earning five and six percent.
• Inflation always costs you money – the purchasing power of the dollar has dropped during the last decades. If your investment strategy doesn’t consider the cost of inflation you’re losing money and usually don’t realize it until it’s done its damage to the purchasing power of your dollar.
• Diversification – One of the most common errors is to become excited about one particular investment and put all or most of your available assets in it. The generally accepted rule is not to have more than 10 percent of your portfolio in one investment, or more than 20 percent in any one industry. Your portfolio should be diversified in such a way as to address all of your needs and goals and at the same time help reduce your risk. There are no hard and fast rules that apply to every portfolio.
• Allow enough time for success – Investing is not a magic money machine. You can’t put $10,000 in on Monday, and take out $50,000 on Friday. It doesn’t work that way. If you’re investing your money in a well thought out, well researched plan, you must give your plan time to work (18 to 36 months). This time frame may have to be altered to allow for unusual circumstances. If you need your money in less time, consider some form of short term money market instrument.
• Keep emotions out of your decisions – Is the potential worth the risk? This requires a rational decision, where you weigh all of the available evidence. Unfortunately, most people ignore reason and get caught up in the emotional high of buying and selling. If you buy on a hunch or feeling about a stock, you usually sell because of fear. The perfect formula for not sleeping very well. Objectivity is essential to successful investing. Treating your investments as a business will help you to maintain a more discipline approach.
In addition to the areas mentioned, a complete financial plan should also take into consideration the number of children, current income, present resources, investment experience, success and failures and planned retirement age. This is far from a complete list of all the factors that should be considered when putting together your financial plan.
Risking your financial future to tips, hunches and favorite stocks can be costly. Consult a reputable financial planner and tax advisor who can teach you how to invest wisely and help guide you through some of the most important decisions you’ll ever make.