The 10 golden rules of investing

This article was originally published on Bankrate.com.

Investing can often be broken down into a few simple rules that investors can follow to be successful. But success can be as much about what to do as it is what not to do. On top of that, our emotions throw a wrench into the whole process. While everyone knows you need to “buy low and sell high,” our temperament often leads us to selling low and buying high.

So it’s key to develop a set of “golden rules” to help guide you through the tough times. Anyone can make money when the market is rising. But when the market gets choppy, investors who succeed and thrive are those who have a long-term plan that works.

Here are 10 golden rules of investing to follow to make you a more successful—and hopefully wealthy—investor.

Rule No. 1: Never lose money

Let’s kick it off with some timeless advice from legendary investor Warren Buffett, who said “Rule No. 1 is never lose money. Rule No. 2 is never forget Rule No. 1.” The Oracle of Omaha’s advice stresses the importance of avoiding loss in your portfolio. When you have more money in your portfolio, you can make more money on it. So, a loss hurts your future earning power.

Of course, it’s easy to say not to lose money. What Buffett’s rule essentially means is don’t become enchanted with an investment’s potential gains, but also look for its downsides. If you don’t get enough upside for the risks you’re taking, the investment may not be worth it. Focus on the downside first, counsels Buffett.

While stocks have been volatile, they’re based on the earning power of global businesses. As earnings rise, so will stocks, at least over time. Contrast that against cryptocurrencies, which usually have no basis—such as earnings or hard assets—to back their valuation. That is, cryptocurrency could ultimately be worth nothing—not the kind of risk that Buffett wants to take.

Rule No. 2: Think like an owner

“Think like an owner,” says Chris Graff, co-chief investment officer at RMB Capital. “Remember that you are investing in businesses, not just stocks.”

While many investors treat stocks like gambling, real businesses stand behind those stocks. Stocks are a fractional ownership interest in a business, and as the business performs well or poorly over time, the company’s stock is likely to follow the direction of its profitability.

“Be aware of your motivation when investing,” says Christopher Mizer, CEO of Vivaris Capital in La Jolla, California. “Are you investing or gambling? Investing involves an analysis of fundamentals, valuation, and an opinion about how the business will perform in the future.”

“Make sure the management team is strong and aligned with the interests of shareholders, and that the company is in a strong financial and competitive position,” says Graff.

Rule No. 3: Stick to your process

“The best investors develop a process that is consistent and successful over many market cycles,” says Sam Hendel, portfolio manager at Kepos Capital. “Don’t deviate from the tried and true, even if there are short-term challenges that cause you to doubt yourself.”

One of the best strategies for investors: a long-term buy-and-hold approach. You can buy stock funds regularly in a 401(k), for example, and then hold on for decades. But it can be easy when the market gets volatile to deviate from your plan because you’re temporarily losing money. Don’t do it.

Rule No. 4: Buy when everyone is fearful

When the market is down, investors often sell or simply quit paying attention to it. But that’s when the bargains are out in droves. It’s true: the stock market is the only market where the goods go on sale and everyone is too afraid to buy. As Buffett has famously said, “Be fearful when others are greedy, and greedy when others are fearful.”

The good news if you’re a 401(k) investor is that once you set up your account you don’t have to do anything else to continue buying in. This structure keeps your emotions out of the game. You’ll continue purchasing stocks when they’re cheaper and offer better long-term values.

Investors who continued to buy throughout the 2020 downturn rode stocks up throughout 2021, and the same will likely apply to future downturns as well.

Rule No. 5: Keep your investing discipline

It’s important that investors continue to save over time, in rough climates and good, even if they can put away only a little. By continuing to invest regularly, you’ll get in the habit of living below your means even as you build up a nest egg of assets in your portfolio over time.

The 401(k) is an ideal vehicle for this discipline, because it takes money from your paycheck automatically without you having to decide to do so. It’s also important to pick your investments skillfully—here’s how to select your 401(k) investments.

Rule No. 6: Stay diversified

Keeping your portfolio diversified is important for reducing risk. Having your portfolio in only one or two stocks is unsafe, no matter how well they’ve performed for you. So experts advise spreading your investments around in a diversified portfolio.

“If I had to choose one strategy to keep in mind when investing, it would be diversification,” says Mindy Yu, former director of investing at Betterment. “Diversification can help you better weather the stock market’s ups and downs.”

The good news: Diversification can be easy to achieve. An investment in a Standard & Poor’s 500 Index fund, which holds hundreds of investments in America’s top companies, provides immediate diversification for a portfolio. If you want to diversify more, you can add a bond fund or other choices such as a real estate fund that may perform differently in various economic climates.

Rule No. 7: Avoid timing the market

Experts routinely advise clients to avoid trying to time the market, that is, trying to buy or sell at the right time, as is popularized in TV and films. Rather, they routinely reference the saying “Time in the market is more important than timing the market.” The idea here is that you need to stay invested to get strong returns and avoid jumping in and out of the market.

And that’s what Veronica Willis, an investment strategy analyst at Wells Fargo Investment Institute recommends: “The best and worst days are typically close together and occur when markets are at their most volatile, during a bear market or economic recession. An investor would need expert precision to be in the market one day, out of the market the next day and back in again the following day.”

Experts typically advise buying regularly to take advantage of dollar-cost averaging.

Rule No. 8: Understand everything you invest in

“Don’t invest in a product you don’t understand and ensure the risks have been clearly disclosed to you before investing,” says Chris Rawley, founder and CEO at Harvest Returns, a fintech marketplace for investing in agriculture.

Whatever you’re investing in, you need to understand how it works. If you’re buying a stock, you need to know why it makes sense to do so and when the stock is likely to profit. If you’re buying a fund, you want to understand its track record and costs, among other things. If you’re buying an annuity, it’s vital to understand how the annuity works and what your rights are.

Rule No. 9: Review your investing plan regularly

While it can be a good idea to set up a solid investing plan and then only tinker with it, it’s advisable to review your plan regularly to see if it still fits your needs. You could do this whenever you check your accounts for tax purposes.

“Remember, though, your first financial plan won’t be your last,” says Kevin Driscoll, vice president of investment services at Navy Federal Financial Group in the Pensacola area. “You can take a look at your plan and should review it at least annually—particularly when you reach milestones like starting a family, moving, or changing jobs.”

Rule No. 10: Stay in the game, have an emergency fund

It’s absolutely vital that you have an emergency fund, not only to tide you over during tough times, but also so that you can stay invested long term.

“Keep 5% of your assets in cash, because challenges happen in life,” says Craig Kirsner, president of retirement planning services at Kirsner Wealth Management in Pompano Beach, Florida. He adds: “It makes sense to have at least six months of expenses in your savings account.”

If you must sell some of your investments during a rough spot, it’s often likely to be when they are down. An emergency fund can help you stay in the investing game longer. Money that you might need in the short term (less than three years) needs to stay in cash, ideally in a high-yield online savings account or perhaps in a CD. Shop around to get the best deal.

Bottom line

Investing well is about doing the right things as much as it is about avoiding the wrong things. And amid all of that, it’s important to manage your temperament so that you’re able to motivate yourself to do the right things even as they may feel risky or unsafe.

Source link