Investing is no rocket science but it can be daunting and overwhelming. To succeed as an investor you need to have a well-thought-out strategy and stick with your long-term goals regardless of market conditions. While there are no rules or strategies that can guarantee success, the tips below can help you invest smarter and more effectively:
Allow your investments to compound
Compound interest was termed the “eighth wonder of the world” for good reasons. The earlier you start saving and the longer you keep your money invested, the more time it has to compound and grow.
Take, for example, a 45-year-old who starts saving $2,000 a year until the age of 65 and generate an annual growth of 6% will have approximately $78,000 in savings. While a 25-year-old who saves the same amount and have the same growth rate will have approximately $329,000 by age 65. If the 45-year-old wants to catch up he would have to save $9,000 a year, about four times the amount the 25-year-old saves annually.
There are great benefits to leave your money invested for a long time, and the sooner you start investing, the better and the more time you will have to grow your investments.
Diversify your portfolio
A well-diversified portfolio can help you mitigate risk during financial turmoil. One rule of thumb to follow when you are diversifying your portfolio is to determine your risk tolerance. A portfolio for a 30-year-old should be different from that of a 60-year-old.
Since assets such as stocks are more prone to market fluctuations and can offset the compounding your investments have gained over the years, it makes sense to take on more assets that are less exposed to market volatility as you near retirement.
You should invest in asset classes that don’t respond to the same market behavior, this way when one asset class is down, another will be up and vice versa. For example, bonds don’t react in the same to the same market forces as stocks and foreign assets are not subject to the same rules as domestic assets. So investing in the right mix of asset classes will help safeguard your portfolio from market risk.
Invest in liquid assets for your short-term needs
One of the reasons why people invest in liquid assets is to be able to convert their assets into cash quickly. You don’t want a situation whereby you need to pay for your kid’s education next week and your money is tied up in the market. So putting some of your money in savings account or investing in short-term securities, such as certificates of deposit and Treasury bills will give you quick access to your money with little to no cost involved.
While you won’t earn much on the money in your savings account and other safe securities, you can at least be sure that your money will be available to you when you need it. The last thing you want is to invest your emergency fund in assets that take an incredible amount of time to convert to cash.
Utilize dollar cost averaging
Dollar cost averaging refers to the principles that allow investors to buy low when markets are bearish and high when markets are bullish. If you don’t want to risk putting lump sum amounts into the stock markets, you can spread the money out over a couple of months by utilizing dollar cost averaging.
For example, if you would like to invest $20,000 you can spread it out over a five-month period. By investing just $4,000 each month for five months you can mitigate risk and keep volatile market forces from depleting your assets. The good thing about this is that you don’t have to predict market movement; you will be doing the same thing each month which guarantees that you will buy at current market prices. You should consider using dollar cost averaging whenever possible.
Rebalance your portfolio
Many times, your portfolio will drift from its original allocation. Take for instance; in a portfolio of 80 percent stock and 20 percent bond, if stocks crash and bonds gain, you will wind up with more bonds in your portfolio than intended. Conversely, if stocks gain and bonds tank you will acquire more stocks than you want. So rebalancing will help you stay invested in the mix of asset classes that match your risk tolerance.
Periodically it’s good to review and rebalance your portfolio but you shouldn’t do it too frequently. If your original portfolio was 80 percent stock and 20 percent bond but after reviewing it you found it’s 79 percent stock and 21 percent bond, the best thing is to leave it alone as there are no significant changes. If you try to rebalance it to the original allocation you might wind up spending more on transaction fees. So only rebalance when it makes the most sense.