There is no doubt that the stock market can be a volatile place, but it can also be a rewarding one. Most financial experts recommend that investors keep a portion of their money in the stock market throughout their lives, even after they retire. Keeping a portion of your money in the stock market is one of the best ways to stay ahead of inflation and make sure your money will last the rest of your life.
But even though the stock market can be very rewarding, it is important to make sure you invest your money wisely. Making a wrong move could be very costly, so it is important to follow the 10 commandments of investing in the stock market.
- Invest automatically – finding the money to invest can be a real challenge, and many people find that there is no money left after the monthly bills are paid. But no matter how tight your budget, it is important to invest for your future. The best way to ensure that there will be money to invest is to make those investments automatically. Contact your employer and direct a portion of your paycheck to a 401(k) plan or other investment vehicle. Since the money comes off the top you will never have a chance to spend it, and since the money invested in a 401(k) is tax deferred you will save money on your taxes as well.
- Keep your costs under control – no matter how you choose to invest your money it is important to keep your investment costs as low as possible. Investment costs can really eat into your returns over time, so it is important to know exactly how much you are paying in expense ratios and brokerage fees. When evaluating the expense ratios for your mutual funds, keep in mind that the expenses on an index fund can be as low as 0.20%. When checking out your brokerage fees keep in mind that many discount brokers charge less than $10 per trade.
- Consider using mutual funds as the core of your portfolio – picking your own stocks can be fun, but unless you are a superior stock picker it is probably best to make low cost no-load mutual funds the centerpiece of your stock market portfolio. Mutual funds invest in dozens to hundreds of different companies, and this helps to spread the risks associated with investing in the stock market.
- Limit exposure to your company stock – employees at some companies may have the opportunity to buy company stock, either through an employee stock purchase program, or ESPP, or through the company 401(k). In many cases the deal may be even better due to discounts available to employees – employees may be eligible to purchase their company stock at a 5-15% discount off of the market price. Even so, it is important to limit your exposure to company stock. After all, your income is already dependent on the health of your company. Investing too much in your company stock could expose you to more risk than you anticipated.
- Track your performance on a regular basis – while stocks are a long term investment, it is still important for stock market investors to keep an eye on how they are doing compared to the relevant indexes. If the stock market has been down, you cannot expect a stock market mutual fund to be soaring. However, you can expect your stock market mutual fund to perform in line with the market overall. If your fund is down more than others during market declines and up less than its peers during bull markets you may want to look for another investment.
- Only buy what you understand – there are many investments out there, some of them so complicated not even the most sophisticated investors can understand them. Investing in financial instruments and derivatives you do not understand is a recipe for disaster, so if you cannot explain what a company does or how it makes money it is best to walk away.
- Diversify your holdings – diversification is an essential part of stock market investing, and it is important to make sure you hold a variety of stocks, bonds and fixed income investments in your portfolio. Never put all your eggs in one basket.
- Take a long term approach to stock market investing – when investing in the stock market it is important to keep in mind that stocks are a long term investment. Never invest money you will need in the next five years in the stock market – keep those funds in short term investments like certificates of deposit and government bonds. This will allow you to ride out the inevitable bear markets without having to pull money out at the bottom of the market.
- Rebalance your portfolio every year – it is important to determine the percentage of your portfolio you want to devote to stocks, bonds and other types of investments. After those percentages are determined it is important to rebalance your portfolio on a regular basis to make sure your ideal asset allocation is retained. If you have had a good year in the stock market chances are your asset allocation is tilted a bit too much toward stocks, so taking some of that money off the table and moving it to bonds or fixed income investments can protect your gains and cushion you in the event of a downturn.
- Do not try to time the market – even experts have trouble timing the market accurately, and the average investor has almost no chance of getting it right. Keep in mind that in order to accurately time the market you will need to be right twice – once at the peak of the market and again when the stock market has reached its low. This is very difficult to do – it is best to just keep investing on a regular basis. That way you will buy more shares when stocks are down and less when they are flying high.