The fundamentals of investment planning
Investing can seem complicated and confusing to many. This can often result in potential investors not investing at all. Breaking down investment planning into some basic fundamentals can get you started on a path to better investing and achieving your financial goals. Anytime you invest in the market there is no guarantee, but understanding some basics can improve the chances for your portfolio’s success – maximizing returns and minimizing losses. This is even more important in today’s world, as the responsibility of funding retirement is shifting more to the individual than relying on social security or pension plans. In so many words, your future is in your hands. Sticking to the fundamentals of investing can help.
Help your portfolio grow by saving
Add money to it. This is the first step. You can let the money you started with work for you as it takes advantage of compound interest. When you put in a principal amount, leave it untouched and assume a conservative annual rate of return, that principal can grow quite a bit. It can grow even more when you aren’t paying taxes on the account, so compounding interest can be quite effective in a tax-deferred Individual Retirement Account or retirement plan. It’s all about time being on your side. If you can put money aside 20 to 30 years, a $10,000 initial deposit will more than double in 20 years assuming a 5% annual interest rate – and more than quadruple in 30 years. This is merely hypothetical, but when compounding interest works, it works in your favor.
When investing – don’t put your money in a single pot
Diversification, also known as asset allocation, is a philosophy that spreads your risk across different classes of investments. Diversifying your portfolio among stocks, bonds, mutual funds, cash and cash equivalents, real estate, collectibles and commodities (such as precious metals) can help you ride out a market’s volatility. If one asset class is experiencing losses due to market conditions, another could be experiencing gains that will mitigate the negative effect.
Determining your asset class mix is an essential decision because it sets the tone for the type of risk you’re willing to take. When you’re younger, a heavier weighting in stocks may be in order because you have more time to recover from a setback. As you approach retirement, it might make sense to invest more heavily in bonds, which tend to have less volatility than stocks.
Take the long-term approach
Investing for the long-term sometimes requires a strong stomach because the market can swing wildly at any time, sometimes resulting in a negative return to your portfolio. If your portfolio takes a hit early, that can eat into its compounding power. Historically though, the stock market has continued to go up over time. While there are no guarantees, sticking with a portfolio that is balanced and diversified over a long time horizon can help manage risk and position it for any profit opportunities.
If you need to access your funds in the not-too-distant future, a long-term approach might not be an option. It could make sense to protect your initial investment in lieu of challenging market fluctuations.
Avoid timing the market
Buying low and selling high is every investor’s dream, this strategy – known as market timing – typically results in unrewarded guessing. A better approach to consider is dollar-cost averaging, where you use a set dollar amount to accumulate shares of a stock, mutual fund or exchange-traded fund on a regular schedule regardless of price. You buy fewer shares when the price is high and more when it’s low. While there is no guarantee this method will result in profit or protection from losses, overall this approach tends to result in a lower average price per share.
When you invest consistently, the guesswork is removed, as is the danger of only buying at the highest share price.
Review and rebalance
When life events, or changes it the market take place, you might find your stock-to-bond mix needs to be tweaked. It makes sense to check your portfolio periodically to ensure your allocations remain true to your plan. Annually reviewing your portfolio and rebalancing it according to its performance and your goals is one of the best habits to form. For example, as your time horizon grows shorter you may decide to reduce your stock exposure and increase your bond holdings, which can provide you with a steady income from bond coupon payments.
Everyone invests for different reasons and while these fundamentals can get you on a good path to the future, it is always a good idea to consult with a professional to ensure you have the best probability of reaching your goals. Our experienced local investment professionals are here to answer any of your questions and help you make informed decisions about where to best put your money.