Fortune Recommends June 12, 2023
Ask anyone, they’ll mostly tell you that investing is the key to building wealth—and the sooner you get started, the more time your money will have to grow. Investing can be intimidating, and like everything else, it comes with risks. On the flip side, it can help you achieve your financial goals, so we’ve put together a list of rules to live by when investing that’ll help you get started.
Money is a representation of something in the future, says Rick Nott, a senior wealth advisor at LourdMurray. And because the future is generally more costly than the present because of inflation, investing can help your money grow over time to beat the rising cost of goods and services.
While no investment is guaranteed to produce returns, there are several rules of thumb worth following.
Before you start investing, you should create an investment plan that aligns with your financial goals. While everyone has different goals, it’s common for many to have some sort of overlap. For example, a common long-term goal includes saving for a house as well as retirement. Once you pinpoint what you want to achieve—and at what age you’d like to achieve those goals—you can calculate how aggressively you’d like to invest.
“Say a couple starts to plan their future: The sooner they decide they want to buy a home within five years or within two years, the sooner they can decide what their actual goals are,” says Timothy Mazanec, a wealth manager with the Harvest Group. “Then you can truly tailor your portfolio to those goals, and you can have a portfolio that matches your risk level.”
Investing 10% of your pre-tax income should be considered the bare minimum, Nott says—20% is his general rule of thumb. If you’re looking to be more aggressive in your investment strategy, that figure can be as high as 30% to 40%.
One of the most important rules of investing is to start as early as possible. This is because it takes time for money that you’ve invested to grow.
Another reason to start early: You can invest more aggressively—that can mean investing in riskier stocks or assets that can yield higher returns because you have more time to recover and meet your financial goals, while potentially having fewer expenses that make it harder to save. Whatever route you choose to take when investing, time is still the most important factor.
The stock market consistently moves up and down depending on a number of factors: the Consumer Price Index and Federal Reserve meetings, for starters. Because of this, it’s never a good idea to try to “time” the market. So don’t worry about negative-tending headlines about the economy or markets, Mazanec says, stressing that your “biggest asset when investing is time.”
“By timing the market, you’re out of the market, and if the market goes up over time, then you’re not participating in that,” Nott says. “ [And] it’s just completely unpredictable… In the long term, the market is driven by the economy; it’s driven by how businesses do. In the short term it is driven by noise and psychological behavior.”
Diversification is the process of spreading your investments across asset classes. In doing so, you’re attempting to offset any potential losses by investing in assets ranging from low to high risk. One of the easiest ways to diversify your portfolio is to invest in something like the S&P 500 stock, which represents the 500 companies listed on the index.
Let’s say a scandal breaks out about a certain CEO of one of those 500 companies. That company’s stock will probably take a hit, but you won’t really feel the impact because you’ll have 499 other companies that you’ve invested in, Nott says.
Along the same lines of diversification, you should consider hedging against potential losses when investing. According to Nott, for most people, “the simple act of diversification is basically a hedge.” In that, you’re hedging one company with another. Still, cash, savings accounts, and bonds are great hedges to stocks, Nott adds.
Don’t be fooled into paying high investment fees and taxes. Let’s start with taxes: Typically you have to pay taxes on the sale of investments if you’ve made a profit—also known as a tax on capital gains. You can minimize your capital gains by using your losses to offset your gains. Let’s say you sold a stock for a $5,000 profit and another at a $2,000 loss in the same year. If you use this technique, also known as tax-loss harvesting, you’ll be taxed the difference—in this case that’s $3,000. Additionally, you’ll likely come across transaction fees each time you enter into a transaction, such as buying a stock or mutual fund. The only way to minimize transaction fees is to limit your number of transactions or lump your transactions together.
It’s crucial for you to understand what you’re investing in, but that doesn’t mean you have to be a financial expert. Instead you should take the time to research your investments rather than simply listening to investment advice from finfluencers on TikTok. That means understanding that if you’re investing in the S&P 500, you’re investing in 500 of the largest companies listed on stock exchanges in the United States. Still, if you’re struggling to get a grasp on what you’re investing in, you should consider working with a financial advisor.
Adding to your investment over time plays to your biggest asset when investing: time. As mentioned above, time is so important when investing—that’s why it’s widely advised to begin investing as soon as possible. The reality is that we all have expenses, whether that means rent or car payments, so we can’t invest most of our income. But investing over time, allows you to pay off those expenses and even have some fun, while still preparing for the future.
There are a few investment strategies that can work here. For instance, there’s dollar-cost averaging, which involves making investments of equal amounts and at regular intervals, regardless of how the stock is doing. Another is lump sum investing, which, unlike the former, involves investing a portion of your cash all at once. They both have pros and cons—for instance, with dollar-cost averaging you’ll likely incur more transaction fees. At the same time, dollar-cost averaging can offset the impact of market volatility on your investments.
If you’re not working with a financial advisor, you need to be reviewing your portfolio annually at the very least, Mazanec says. In his view, you would ideally be working with a financial advisor, someone like himself who does this every day and can gauge the market and make the right decisions for your investments.
Like adding to your investment over time, holding your investment long-term is really important to building your wealth, generating more profit. Your money needs years to grow, and with time, it can grow exponentially and generate higher returns. Nott says that if you have money you know you’ll need two years from now, it shouldn’t even be in the market.
Not to mention that there’s something called unrealized losses. Essentially, if you’ve got money in the stock market, and you see your investments have gone down, it’s not a real loss until you pull out.
“What you see on paper, on your screen, is not necessarily the outcome,” Nott says. “If you put money into the market at $1,000 on January 1, 2022, and now you have $800, that doesn’t mean that’s all that you have, [it’s] the temporary value of that money. If you could hold it for the time period that you should, which is at least five to 10 years, there’s a very high probability that you are going to see return and growth out of that.”
There’s a general consensus that investing can help you achieve your financial goals, giving you a leg up. The key? Start early. That way your money will have the time it needs to generate higher returns. But also identify your financial goals, so that you can tailor your investment portfolio accordingly.
Investing can be intimidating and risky. But there are ways to deal with that and increase your appetite for risk; sometimes that means starting small, and sometimes that means balancing your cash with investments as a safety net. Either way, there are resources out there to help you get started, such as investment books and financial advisors.
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