So there you go – that’s it!
Okay, I’m just kidding… kind of. Let’s talk about that. People get really nervous when it comes to investing. They think to themselves, “I don’t know anything about the market – I can’t invest! That’s for professionals.” And while it’s true that there are plenty of professionals out there to help you (for a nice fee), it’s not true that you can’t do it for yourself. I’m looking at you, Ms. English Major: You’re perfectly capable of doing this for yourself.
Whether you choose to get help or not, investing is a must. It’s the only way your money has the chance to grow significantly. We’re not talking just keeping up with inflation, we’re talking making a return that will give you a healthy and stable financial future.
And yes, there is risk. The greater the risk, the greater the potential reward. That’s life, and that’s also why any money you invest should be money you’re comfortable not seeing for at least a few years – my general rule is five. (For a recap on your option for investing in the short term, revisit this post.) And now, the rules…
The Law of Diversification
Some people say this is the only rule to investing, and I almost agree. Diversification, in investing, means spreading your investment risk around. Didn’t your mom tell you to never put all your eggs in one basket? That’s the Law of Diversification. When it comes to your investments, you can diversify in two main ways:
Diversification of assets. This simply means investing in different companies. This can additionally mean spreading your investments around to different industries, different countries, etc., but at the end of the day, it means that your retirement is not dependent on the health of one entity – even if that entity is Google.
The easiest way to diversify is to put your money into index funds. Index funds group many investments together to track market indices, like the S&P 500. Without getting all technical on you, the S&P 500 is a list of stocks that are generally thought to reflect the US stock market, which has, over the last century, returned an average of 10 percent per year (Note, however, that this includes the Great Depression, and also the boom of the Internet-bubbled 90s. That’s why investing for the long term is so important – it gives your investment a chance to ride the waves out.).
So, if you invest in an index that tracks the S&P 500, then what you are doing is investing in the US stock market. In general. All at once. Because with an index fund, rather than having to split your $1,000 investment among 500 US companies – which, by the way, would kill you in fees – you invest your $1,000 into the fund, like the Vanguard 500, and boom! You’re diversified 500 ways. It can feel like this is the lazy man’s way of investing, but think of it as getting the most bang for your buck.
Diversification of timing. Timing can be a tricky thing. Is now a good time to invest, or will stock prices lower? There’s no guaranteed answer to that, so the best way I’ve found, if I’m concerned about timing, is to make sure I’m investing at different points in the year. If you have a $1,200 investment, invest $400 today, $400 in three months and $400 three months after that.
Don’t Try to Predict the Future – Trust Your Investments
I don’t know what the market will do tomorrow, much less next year or when I’m 50. And part of that is the fun – I can take a gamble on a startup and potentially make it big – but if that’s scary to you, don’t worry about it. You don’t have to pick the next Apple, just invest in companies you trust.
First, another plug for index funds. Trust the American market? Index it up.
But if you want to buy individual stocks, the key is really doing your research. There are two types of stock investments: growth stocks and value stocks.
Growth stocks are those that we invest in because we believe in the potential of the company: The value of the company is weighted heavily towards what it will do and how it will grow. These investments can provide some of the highest returns if you pick right (think investing in Apple 10 years ago), but they are some of the worst if the company either doesn’t go anywhere (all that potential lost!) or the stock is so hyped up (think Apple now) that it’s over-valued and the price can’t go much higher.
Value stocks are investments in companies that are generally more mature – think Coke – but we think are under-valued in the market. Sound too scary? If you’re investing for the long term (which you should be!) this really just means investing in strong companies you believe in. Log into Yahoo! Finance and do your research if you’re not sure about the strength of a company. Here are some questions to consider:
– Does the company have a sustainable competitive advantage? In other words, what makes this company run better or gain a wider market share than everyone else? Do you believe it can keep that up?
– Does the company’s leadership team have a good track record? (My investment into Lululemon, with its recent CEO debacle, hasn’t served me so well.)
– Does the company have a lot of cash on hand? The reason this is important is because cash is actually what makes the world go round. Companies can’t do anything without cash, from paying their employees to investing in new projects. So do your research and read the company’s statement of cash flows (Here’s an easy tutorial on how to do just that from my favorite finance website, The Motley Fool.)
…and if you invest in both growth and value stocks? You guessed it – another way to diversify!
…I guess diversification really is the only rule to investing.