Investing doesn’t have to be complicated and you don’t need any fancy degree or work experience to do it. Anyone can be successful at it too! But to be successful, you need to understand some core principles behind investing. Below are 6 simple principles that will help anyone succeed when investing! Take a look and let us know if you have any additional principles you follow!
Start early
The earlier you start investing, the more compounding interest will take effect and benefit you big time. Compounding interest, put simply, is interest earning more interest. As your interest earns interest, linear growth becomes exponential and suddenly the dollar you originally invested is worth much, much more.
For example, the graph below shows two different investors. One invested $10,000 (“Investor A”), the other $35,000 (“Investor B”), assuming a 10% annual growth rate. Can you guess which line is which?
If you guessed the blue line is Investor A, then you are absolutely right! How is this possible? By starting early, and letting compounding interest do its thing. In this example, Investor A put aside $1,000/year from age 21-30 and never put aside another dime. Investor B started investing at 31, also putting aside $1,000/year, and invested until he/she was 65. Investor A’s $10,000 investment was able to gain more momentum and capture the positive effects of compounding interest more than Investor B, who ended up investing more over a lifetime. This goes to show, we need to start early! (And really, we should be a mixture of the two investors by not only starting early, but continuing to invest the money throughout our lives, and not just for a few years.)
Ideally, we all should’ve started investing as kids, but if you are anything like me, you had no idea investing was a thing, let alone knew how to do it. But it’s not too late to start now, regardless of how old or young you are. Investor B may not be as well off as Investor A, but Investor B’s $35,000 still turned into almost $300,000! So wherever you are at in life, just start ASAP!
Diversify
Let me tell you a tale of two stocks from personal experience.
Stock 1:
I had known that I wanted to invest for a while now, but lack of know-how kept me from doing so. Finally, I had a friend kind of show me the ropes a little bit and I went for it. One of the first things I invested in was a stock of a company that I only knew because I knew and respected one of the VPs. I didn’t really know what the company actually did. At the time, the stock was trading for about $35/share and I bought around 11 shares. In the first month or two, things were great! My investment went up by $20 or so and it felt great. Then the volatility and reality of stocks showed its ugly face and over the next few months, the investment went from trading in the mid-$30s to a whomping low of about $12. I had seen my investment lose roughly 65% of its value in probably less than year. Yikes! It took another year or two just to break even, and at that time I cashed out as fast as I could.
Stock 2:
Fast forward a year or two from the investment in the first stock. I had learned a bit more about investing and had made better choices since then. One day, I happened to look into Apple’s stock and noticed that it had dropped to about $99 a share, when it had once traded for much more than that. I decided to jump on that and purchased a grand total of 1 share! But hey, I was a poor college student, so I couldn’t do much more. I held that stock for almost two years, and during that time I watched that stock go from $99 to about $176 when I finally sold it. That was awesome! Easiest money I’ve ever made.
So why do I tell these stories? Well, quite simply because I wouldn’t recommend investing in stocks at all. Sure, one experience was positive, but the other one was quite painful. Principle #2 is all about diversifying. What are we diversifying exactly? We aren’t just trying to diversify what we own, we are trying to diversify risk. Owning stock in a single company is by definition, the opposite of diversifying your risk. You are literally putting all your eggs in one basket, hoping that the basket doesn’t fail you. So if you decide you want to invest in stocks, keep this in mind.
In order to diversify risk, you want to own a variety of shares in companies that are in a variety of industries. This means, not investing all of your money in technology alone, but investing in utilities, consumer products, etc. The easiest way to diversify your risk is through mutual funds or ETFs that track indexes such as the S&P 500. A little research can go a long way when it comes to diversifying risk. We will have future articles outlining how to do this research and try to make it as simple as possible!
Now, keep in mind there will always be some form of risk involved. But without risk, there is no reward. The key is being wise about the risks you take.
Seek low-fee investments
The last thing you want for your investments is to see a lot of value lost through high management fees or other expenses. This is why you want to find ETFs (exchange-traded funds) and Mutual Funds that have low management fees and expenses. Anytime you look up a ticker symbol of an ETF or Mutual Fund, it will tell you the fee rate. It doesn’t take a genius to know you want this number as low as possible.
ETFs that track an index (such as “SPY”) generally have very low expense rates that can be less than 0.1%. This is due to the fact that they are not actively managed by fund managers who are trying to outperform the market (and who usually fail to do so). A good rule of thumb is to try to find funds that have net expense ratios of 0.6% or less, but the lower you can get this, the less money you’ll lose on fees with your investment.
Avoid investment vehicles you don’t understand
If you read our Steps to Wealth Building article, you know we are fans of K.I.S.S. (keep it simple stupid), and the same applies here. Complicated investments are rarely worth it. Most of the time people are just taking advantage of others’ ignorance and making a fortune off of fees and commissions. Investing in the market as a whole is a simple way to invest and it’s proven to be a great long-term investment. You don’t need complicated. If you don’t understand the investment, chances are it’s not worth it.
Take advantage of employer matches on 401(k).
This is pretty simple: any employer match is an immediate return on investment. So take advantage of this! Our recommendation is to invest just enough in the 401(k) to receive the maximum match. The rest of your investment should target tax-advantaged instruments such as Roth IRAs.
Invest for the long-term
Remember, investing isn’t about right now, it isn’t about 5 years from now: it’s about the long-term! So try not to get too caught up in the natural volatility of the overall market. Things happen, prices change. But in the end, the market always goes up. Check out this graph of Gross Domestic Product (GDP) over the last 40 years.
GDP is a measure of overall economic and market health and the graph shows that is has always trended upward. The gray bars that occur periodically are recessions and their respective lengths. You’ll notice that recessions seem to happen every 5 or 10 years. This can be scary for a lot of people wanting to invest. But this shouldn’t stop you from investing. Recessions happen, but if you keep your mind-set on the long-term, these recessions shouldn’t phase you. Invest, and let your investments sit. They will assuredly rise and fall, but in the end, the market always goes up.
The other big reason to invest for the long-term, is to take advantage of tax law. Any investment held over 1 year is no longer subject to your ordinary income tax rate, but will now be subject to a much more favorable capital gains tax rate once the investment is sold.
As the table shows, the capital gain rates are much more favorable than ordinary income tax rates. So make sure that when you invest, that you hold it longer than a year if possible! Keep more money in your pocket.
Recap
Let’s do a quick recap of our 6 principles for successful investing:
- Start early
- Diversify
- Seek low-fee investments
- Avoid investments you don’t understand
- Take advantage of employer matches on 401(k)
- Invest for the long-term
These are simple principles that will help you to become a wise investor. Look out for our future articles that will go more into detail about investment strategies, and investment research!
Are there any other principles you abide by when investing? Comment below!
Really, I found it very interesting. Thanks for sharing.