Stock Market 101
Ten proven strategies for maximizing your investment returns
Whether you’re new to online stock market investing or you’re a seasoned veteran with years of experience using the best online stock trading platform, read this before you invest another penny.
It doesn’t matter if your money is tied up in an employer’s 401k or you’re running your own self-directed retirement fund. The right investment strategy can place you at the top of your financial game.
1. Do you have a financial roadmap?
Before you begin investing, sit down and take an honest look at your current financial status.
Do you have an emergency fund of three to six months’ living expenses? You’ll need this in case of a job loss or terrible market performance. What large purchases are in your foreseeable future? Your investment dollars should come from funds not already allocated to other plans.
2. Check your tolerance for financial risk.
Some investors are in it for the thrill. These may be day traders, hoping to make a quick buck risking a large sum of money on an unpredictable swing in a particular stock or other investment.
Day trading can become an obsessive addiction akin to gambling, so be careful if you have a history of addictive tendencies. The reward for taking on such risk can seem like a sure bet but just like in Vegas, the house always wins. Investments in the stock market are not insured against loss, and you could lose more than just your shirt.
The best strategy is to invest for the long-term; this is where the greatest returns can be found. The average annual return for the Dow Jones Industrial Average since the Great Depression is 11.1%. A thousand dollars invested in 1932 and left alone would now be worth $6,899,444.29 (daveramsey.com). It would have been worth one million dollars in 1975, and your itty bitty investment of one thousand dollars in 1932 would grow by nearly 6 million dollars between 1975 and 2012. You won’t get those kinds of returns with a short-term stock market investing.
3. Consider Diversification
Di-what?!? The website thefreedictionary.com defines diversification as “To distribute (investments) among different companies or securities to limit losses in the event of a fall in a particular market or industry.” It’s basically ‘not putting your eggs in one basket.’ Oftentimes the various investment vehicles (stocks, bonds, and cash) move up or down at Credit: Flickr user jronaldleedifferent times, and often in different directions.
Nobody knows which way anything is going at a particular time, although there are indicators that give us a pretty good idea and take the risk out of investing in one particular type over another. It’s best to have a good mix of stocks and bonds in your portfolio. That way if the market all of a sudden takes a nosedive and your stocks aren’t doing so well, your bonds will make up for the losses of your stock investments.
Cash isn’t a good choice for an investment, because if it’s just sitting there, the power of inflation will erode its value at the rate of about 4% per year.
Every individual investor will find his or her preferred ratio, but since stocks tend to outperform bonds by more than 4 percentage points per year, it makes a strong case for a stock-heavy portfolio. Held for the long-term, a 100% stock portfolio has proven to provide the best returns . So buy and hold, but know what you’re buying.
4. Limit Investments in Your Company’s Stock
When you walk in some place every day, it’s easy to drink the kool-aid and believe all is well. Be careful here, because you don’t know everything you need to about your company. You know your area well, and maybe a little about what’s going on in the other departments. But for any company that’s large enough to have gone public and provide stock as a benefit or incentive, it’s much too large for one person to see the whole picture from the inside.
Remember Enron? Yeah, they thought everything was fine. After the dust from the company’s collapse settled, employees received less than 5% of the $2 billion that the company owed to them. Each of the 20,000 employees received an average of $3,100, a far cry from the average of $73,000 that was owed each employee for their stock contributions.
5. Save For a Rainy Day
Credit: Flickr user jronaldleeGrandma was right when she taught you to ‘save for a rainy day.’ There’s no way to tell
when the market will take a major hit, or when your house needs a new roof, air conditioner, and furnace all in the same year. Or worse. If you’re still working your way out of debt, start with a $1,000 Emergency Fund. If you’re debt free (except the house), aim for at least 3 months’ worth of living expenses for your family to survive in case of an unplanned career change or other emergency.
6. Pay Off All Your Debts
If you are carrying consumer debt such as credit cards, personal loans, student loans andautomobile leases and loans, pay those off first before you begin investing in the stock market. The interest you pay on those debts is costing you your future, not only in the interest you pay every year but also in the payments you have to make to your creditors.
With the average car payment at $492 per month, that
equates to $4.4 million dollars when invested and left alone for 40 years. That new car smell isn’t so nice anymore, now is it?
7. Be A Consistent Investor for the Best Prices
No, there isn’t any club in which regular investors receive better prices for investing in the stock market. But as we learned earlier, there is no way to time the market. By investing on a regular basis, you take advantage of what’s called ‘Dollar-cost Averaging’. It’s natural for the price of your investments to fluctuate, sometimes daily.
When you invest monthly, you get to buy the same stock when the price is low, giving you more room for potential growth. Conversely, when your investment’s price is high, you get less of the stock and face a slightly lower potential return. As a more consistent investor you avoid the risk of investing a year’s worth of savings at the wrong time and even out the bumps in the road. Investing using dollar-cost averaging also helps you avoid the quandary of “what stock should I buy now?” because you can invest in something different every single month.
8. Take Advantage of Your Employer’s Matching Contributions
Free money, anyone? Many employers offer company matching on a small part of your monthly savings for retirement, often into your 401k. A good 401k investment strategy includes the option to receive this match, sometimes as much as 100% of what you invest yourself, thereby doubling your investment.
If your employer offers a matching contribution, take it. Invest to get the largest matching contribution, and no more. Some plans require you to invest in the company’s stock to receive the match, which is fine as long as you invest only to the point of maximizing your employer’s matching contribution.
9. Perform an Annual Rebalancing Act
If you’re a pretty hands-off investor, there’s good news: your investments tend to perform better over the long-term than the investments of short-term investors. This is mostly due to fees related to short-term trading that a more anxious investor gets wrapped up in and the Credit: Flickr user bitzceltassociated risk of trying to time the market. This doesn’t mean you should ignore your portfolio entirely, though. Over time, certain investments in your portfolio will outperform others and grow faster in value.
If you have a portfolio of 50% stocks and 50% bonds, you may see a positive shift in your stock allocations after a good year for the stock market.
Rebalancing simply means selling a few investments to buy a few others to keep your assets invested in the desired percentages. By setting a desired allocation for your portfolio, you can have a good benchmark for how to adjust when the time comes to rebalance.
10. Avoid Potentially Fraudulent Situations
Not all risk is completely avoidable. If you’ve read this far, you know that already. But be careful when receiving unsolicited advice. Relationships take a long time to develop, and can vanish in an instant. Don’t get caught up with someone who has it the other way around.
Ask lots of questions and always do your own research. Never rely solely on the advice of another person, no matter their credentials or background. It’s your money, and you alone decide how to invest it. Always remember Warren Buffett’s rule for investing in the stock market: “Never invest in anything you don’t understand.”
There are many resources for the beginning and experienced investor alike. Read as much as you can before investing in the stock market for the greatest returns. It will be money well-invested, perhaps even better than those "hot stocks to buy now" tips from your broke brother-in-law.