If you’re investing in stocks to achieve financial security, following these 11 simple tips could help you avoid mistakes and build a bigger nest egg.
1. Buy and hold, and hold, and hold
There’s no secret sauce to stock market success, but perhaps, the best (and arguably, hardest to follow!) advice is to buy shares in great companies and hold them for decades.
Sticking with stocks through bear markets can be hard, but historically, patience has outperformed short-term trading. Why? Because it’s hard to know when it’s safe to buy shares after selling them, and that can lead to missing out on some of the stock market’s best performing days. For example, an investor who stayed the course through thick and thin earned a 339% return between Jan. 1, 1997 and Dec. 31, 2016; however, if they missed the 30 best performing days during that period, they’d have lost money, according to JP Morgan Asset Management.
2. Keep some cash handy
If you’re one of the millions of Americans without an emergency fund, you could be making a big mistake. The last thing you want to do is tap your stock portfolio for money during tough times. If you do, you could wind up selling shares when you should be buying them.
Similarly, it can pay-off to have a little cash handy in your investment account. Holding cash won’t earn you much of a return, but it can allow you to take advantage of the stock market’s inevitable drops. Since 1950, there have been 36 periods when the S&P 500 has fallen by over 10% and investing during those corrections improved the odds of investment success. The ability to profit from bear markets is one reason why some of the most successful investors of all time, including Warren Buffett, always keep some cash in their portfolio.
3. Dive into dividend stocks
One of the easiest ways to give your stock market returns a boost is investing in dividend paying stocks and then, using your dividend payments to buy more shares. According to Schroders, reinvesting dividends nearly doubles the return of the MSCI World Index to 640% from 323% since 1993. Because reinvesting dividends can help investors benefit from compounding and dollar-cost averaging, make sure dividends are reinvested from day one.
4. Don’t fear disruptive companies
Henry Ford didn’t just make cars, his affordable cars and trucks helped change America. Disruptive companies don’t come along every day, but when they do, the impact on your stock portfolio performance can be significant. Unsure what a disruptive company looks like? Think about how Amazon.com helped transform how people shop, or how Facebook changed how people communicate, or how Netflix changed how people consume entertainment.
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5. Invest alongside great leaders
When you buy stock in a company, you’re trusting that company’s management to make smart decisions that grow revenue, boost earnings, and ultimately, deliver shareholder-friendly returns.
Unfortunately, not all CEOs will succeed. To reduce the risk of investing in a poorly run company, learn more about the person who runs it. Does the CEO own a lot of shares? Do employees rank the CEO highly? If a significant amount of a CEO’s net worth is tied to the company’s performance, it’s a good bet they’re as interested in increasing the company’s long-term value. Also, because great managers tend to inspire great employees. A top-notch manager is worth trusting with your money.
6. Diversify your holdings
It can be tempting to bet the ranch on one or two stocks, but even the best companies have seen their share prices decline by eye-popping amounts during their history. For instance, Amazon.com’s stock has dropped by 10% or more in 29 months since 1999, including five months when it fell by over 30%. Even scarier, Wall Street is littered with once-successful companies like Enron that went bankrupt, wiping out investors in the process.
Because share prices can swing wildly, creating a portfolio that spans multiple sectors, such as healthcare, financials, and technology, and includes different sized companies, can reduce the risk you’ll lose all your money if a stock goes belly up.
7. Avoid profit-busting fees
When it comes to investing, there aren’t any free lunches. If you invest in the stock market through a broker, you’ll pay commissions every time you buy or sell a stock, or you’ll pay a management fee. If you use a mutual fund or an exchange-traded fund (ETF) to buy stocks, you’ll pay fees, too, even if those investments are in a retirement account.
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The toll that fees take on your portfolio is significant. According to Vanguard, a person paying 2% fees on a $100,000 investment returning an average 6% annually for 25 years would end up with an account balance that’s $260,000 smaller than if they didn’t pay any fees at all.
8. Invest in an IRA
Even if you contribute to a workplace retirement plan, you can still contribute to Roth IRA if your household income isn’t above annual limits. If you’re married filing jointly, you can contribute the maximum $5,500 to a Roth IRA in 2018 if your household income is below $189,000. If you’re single, you can contribute the maximum if your income is below $120,000. You won’t get a tax deduction on your contributions, but your money will grow tax free, including gains on your stocks, after five years has passed since your first contribution.
If you already invest in a retirement plan at work, but you prefer a tax break on your contributions up front, you can invest a maximum of $5,500 in a traditional IRA in 2018 and then, deduct the contribution from your tax return. You can take the deduction as long as your household income is below $101,000, if you’re married filing jointly, or $63,000, if you’re single.
9. Make the most of your workplace retirement plan
If you work for somebody else, you can probably contribute money to a 401(k) or 403(b) retirement plan and if you’re self-employed, you can contribute to a Simplified Employee Pension (SEP) IRA or a similar product. While many people take advantage of these plans, few people contribute the maximum amount possible to them. In 2018, employees can contribute up to $18,500, or $24,500 if you’re age 50 or older, to a 401(k) or 403(b) plan. If you have a SEP-IRA, you can contribute 25% of compensation up to $55,000 in 2018.
If you can’t contribute that much money immediately, see if your plan offers automatic escalation, a feature that increases your contribution rate every year. Automatically increasing your contribution rate can be easier on your budget and it can pay off handsomely. For example, a 30-year old earning $40,000 per year, who contributes 3% of income, and earns a 6% return annually, would wind up with a nest egg worth $133,721 at age 65. Increase that contribution rate to 10%, and that portfolio would be worth $445,734 at 65.
10. Dollar cost average your investments
No one knows when the market will pop or drop and because of this, investing is risky. There’s no way to guarantee against losing money in the stock market, but dollar-cost averaging can make it less likely. Investing the same amount of money on a fixed schedule, such as monthly, means you’ll be buying fewer shares when stocks are up and more shares when stocks are down. Assuming the stock market trends up over time, dollar-cost averaging will keep your average cost low, increasing the odds of successfully making a profit.
11. Invest sooner, rather than later
The earlier you begin investing, the less you need to invest every year to reach your savings goal. For instance, if you’re 25-years old, you only need to invest $500 per month to wind up with $1 million at age 65, assuming a hypothetical 6% annual return. Wait until age 35, and you need to sock away nearly $1,000 per month to end up with the same amount of money. Why the big difference? Compound interest, or the ability to earn interest on interest. Start investing early and your money will work harder for you.