If you’re new to investing, it’s pretty easy to feel overwhelmed. The factors of sound investment may seem complicated, but here’s the truth: It doesn’t take a Ph.D. in finance to be a good investor. In fact, the most important investment decisions you have to make are actually pretty simple.
1. Your Savings Rate
The amount you save is far and away the most important factor as you start investing. Nothing else comes close. You’ll hear plenty of people talk about ways they think you can get better returns. And you’ll hear plenty of other people who warn you away from the stock market because you could lose your money. Neither of those things matters. At least not very much when you’re starting out.
So how much should you save? You can start saving something and slowly increase that amount over time. Maybe you increase your savings rate by 1% each year, or put 50% of all raises towards savings (or both!). Those small changes can really add up over time. However you do it, focus first and foremost on the amount you save. No other factor will have as big of an impact.
2. What You Invest In
Asset allocation is the fancy term for how you decide to divvy up your money among different types of investments. And this is an important decision, In other words, deciding to invest in the stock market will have a big impact on your returns. But the specific stocks you pick matter a lot less.
And at the highest level, your main decision will be how to split your money between stocks and bonds.Stocks represent ownership in a company. They offer the highest potential return, but also the highest risk of loss.
Bonds are actually loans you give to companies. Just like a loan you would take out personally, they pay an interest rate and over time the entire loan is paid back. They don’t offer as much return as stocks, but they also carry less risk. Your big decision is essentially how much of your money to put toward each.
3. How You Diversify
Diversification is another fancy word that investment people like to throw around. But all it really means is investing your money in a lot of different things instead of putting all your eggs in one basket.And diversification is important because it’s the only way to decrease your investment risk without decreasing your expected return.
4. What You Pay
With most things in life, you can expect that higher quality comes at a higher price. Not so with investing. As Vanguard founder John Bogle once said: “In investing, you get what you don’t pay for.” It turns out that one of the best ways to increase your returns is to lower your costs. The less money you pay for the privilege of investing, the more you have available to invest in your future. Watch fees like a hawk and watch your returns improve.
5. Sticking to Your Plan
There will be many times where you’re tempted to change your investment strategy. When the market is up, you may want to be more aggressive. When the market is down, you may want to get out. When your co-worker is bragging about the stock he just bought, you may be tempted to buy it, too. Many investors give in to those temptations and end up with returns that lag the market as a whole. They end up buying high and selling low, just the opposite of what you want to do. To avoid that, you’ll have to tune out the noise and keep doing what you set out to do, no matter what kind of craziness is happening all around you. Stick to your contributions. Stick to your investment choices. Don’t let the news of the day change your mind. It’s not easy, but that consistency will keep you on track through the ups and downs.
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