10 Investing Concepts to Ignore and 10 to Follow
So you're ready to invest. Awesome! Investing is one of the simplest — although not easiest — ways to build wealth. To help you on your road to success, here are 10 things to ignore, and 10 to keep in mind. (See also: 7 Investing Lessons From the Two Comma Club)
Ignore This Stuff
Let's start with what you should ignore.
1. Hot Managers
A fund manager may be able to pick the right investments once in a while. But can he do it over the long term? The answer is likely no.
2. Hot Stocks
Sure, you could pick the next Apple and strike it rich. But you could also pick the next Enron and go broke. It's much safer to diversify.
3. Hot Sectors
Should you focus on the financial sector? How about the technology sector? The answer to either question is no. Remember the financial crisis of 2008? The dot-com bubble back in 2001? Instead, by investing in a broad market, this won't matter, because you'll be owning all sectors.
4. Daily Performance
In the short-term, the market is moody. Prices go up and down all the time. Stay focused on the long term.
5. Financial News
A lot of the news out there is useless, and sometimes even used to scare you. Ignore the news.
Often, these people will want you to buy and sell with great frequency. But not for the reason you may think. Since you pay commissions for every trade you make, frequent trading makes brokers rich, not investors.
7. Market Timing
Trying to predict when to buy and sell is a waste of time. No one can accurately predict the future.
8. Morningstar Ratings
A study of the funds rated "five stars" by Morningstar failed to find evidence that these funds did any better than the four star, or even three star funds.
9. Past Performance
As the saying goes, "Past performance should not be used to predict future performance."
10. Social Security
I'm not counting on Social Security in my retirement. In fact, according to the Social Security Administration, the Old-Age and Survivors Insurance, and Disability Insurance (OASDI) Trust Funds are expected to become depleted in 2033. So it helps to plan not to have it. Anything you do get will be icing on the cake.
Pay Attention to This Stuff
Now, let's dig in to the things you must get right.
1. Asset Allocation
There are two main types of assets: Stocks and bonds. Stock prices move up and down more wildly than bonds. But they also have the chance to make you more money. Asset allocation is how you'll divide your money between the two.
"Why is this important?" you ask?
Studies have shown that your asset allocation makes up 90% of the expected returns you'll achieve.
Related to asset allocation is diversification. This is about how deep you go into stocks and bonds. It's risky to own just one stock or one bond. The more you own, the more diversified you are. This leads to more safety, helping you sleep better at night while your money still grows.
If you'd like to see how I allocate and diversify my assets, check out the Core Four Portfolio.
Since stock and bond prices will go up and down, you'll need to make sure your asset allocation stays on track. This is what rebalancing does.
4. Time Horizon
Investing isn't a get-rich-quick scheme. To win the game, you need patience and lots of time in order for your money to grow.
If you're going to invest in mutual funds, the most important fee to be aware of is the expense ratio. All funds have them. It's crucial to make sure that you're paying the lowest fees possible. The more they charge, the less you keep.
6. Dollar Cost Averaging
This is all about the consistency you bring to investing with regular purchases, which tends to average out the highs and lows. So, if prices are down, there's a sale, and you're buying in preparation for when prices rise again. If prices are up, you're still buying, and your portfolio is growing as well. A win-win situation.
7. Contribution Limits
The more money you contribute, the faster you build wealth. In 2013, you can contribute a maximum of $17,500 to your 401(k) and $5,500 to your IRA.
8. Employer Match
If your employer provides a retirement plan with matching contributions, invest at least enough to get the match. As part of your compensation package, this is money you're entitled to. It'd be unwise to pass up this extra money.
9. Risk Tolerance
How much risk can you take? If you're young, you can usually take on more risk by investing in a greater amount of stocks. But as you get closer to retirement, you'll probably want to decrease risk by having more of your money in bonds.
Lastly, lots of people don't like to think about death, even though it's inevitable. Choosing your beneficiary will ensure that the person whom you want to receive your money will actually get it.
Ignore the first 10 things above, and follow the second 10, and you'll be on the road to investing success.
Anything I've forgotten in these twin lists? What investment advice do you ignore? What advice do you stick with?