Investing is a big part of any successful financial plan, yet many people lack confidence in their investment abilities. Lack of knowledge is cited as the primary barrier to getting involved in managing one’s investments.
Knowledge builds confidence. Take a class on investing, read books, search the internet, talk to successful investors. As you gather information, remember: nobody’s perfect when it comes to investing. Nobody wins all the time. Successful investing is making money over the long term.
What areas of investing should you learn about? Stick to basics at first. Learn the vocabulary of investing; the various asset types and classes. Understand the concepts of risk and reward; diversification; and portfolio allocation. (Your ‘portfolio’ is the collection of assets you hold.) Know how inflation affects purchasing power. Embrace patience and discipline.
Here are a few important items to remember:
- Markets go up and markets go down (market volatility.) Investing involves risk. The key is understanding and managing that risk. During the recent economic downturn, many investors looked at their quarterly statement and said, “My portfolio LOST XX% of its value!” But until you actually sell an asset, your loss is only on paper. Stay the course; give your investment a chance to recover (see next point.)
- Stocks are perceived to carry a high level of risk. Since 1926, common stocks have yielded an average annual return of 11.2% and moved well ahead of inflation. The worst annual return in the history of the S&P 500 index was in 1931, when the market dropped a record 43.3%. Two years later, the market recovered with a record increase of 53.5%. Stay the course; investing for the long-term brings better results.
- No one can consistently predict the rise and fall of the market. If experts can’t do it, it’s a sure thing novices can’t do it. Trying to do so is called “market timing” and it’s a bad idea. A $10,000 portfolio invested in the Dow Jones Industrial stock group from March 31, 1996 through March 31, 2011 earned an annualized total return of 7.71% when left fully invested. If an investor making sales or purchases had missed only the 10 best days of that 15-year period, the return would have declined to 3%. Missing the 40 best days would have resulted in a loss of 4.66%. Embrace patience and discipline; investing for the long-term brings better results.
- Investing is based on the concept of risk and reward. Ideally, greater risk brings a greater reward. Being excessively conservative can be costly because of lower returns on investment. Different types of investments work best for different people, different goals, different time horizons. This is why you need a good grasp of your individual financial situation.
Are you just getting started on investing? Do you have questions? Let us know in the comments below, and be sure to check back for more investment help in Investing 101.