A successful investor maximizes gain and minimizes loss. Here are six basic principles that may help you invest successfully.
Long-term compounding: Your nest egg may get bigger, and bigger, and bigger
It’s the “rolling snowball” effect. Put simply, compounding pays you earnings on your reinvested earnings. The longer you leave your money at work for you, the more exciting the numbers get. For example, imagine an investment of $10,000 at an annual rate of return of 8 percent. In 20 years, assuming no withdrawals, your $10,000 investment would grow to $46,610. In 25 years, it would grow to $68,485, a 47 percent gain over the 20-year figure. After 30 years, your account would total $100,627. (Of course, this is a hypothetical example that does not reflect the performance of any specific investment.)
While you should review your portfolio on a regular basis, the point is that money left alone in an investment offers the potential of a significant return over time. With time on your side, you don’t have to go for investment “home runs” in order to be successful.
Endure short-term pain for long-tern gain: ride out market volatility
It sounds simple, doesn’t it? There’s no denying it–the marketplace can be volatile. Still, it’s important to remember two things. First, the longer you stay with a diversified portfolio of investments, the more likely you are to reduce your risk and improve your opportunities for gain.
Second, during any given period of market or economic turmoil, some asset categories and some individual investments historically have been less volatile than others. Although past performance cannot predict future results, you can minimize your risk somewhat by diversifying individual assets within each class.
Asset allocation: spreading the wealth
Asset allocation is the process by which you spread your investment dollars over several categories of assets, usually referred to as asset classes. There are two main reasons why asset allocation is important. First, the mix of asset classes you own is a large factor–some say the biggest by far–in determining your overall investment portfolio performance.
Second, by dividing your investment dollars among asset classes that do not respond to the same market forces in the same way at the same time, you can minimize the effects of market volatility while maximizing your chances of return in the long term. Ideally, if your investments in one class are performing poorly, you will have assets in another class doing well. The gains in the latter will offset the losses in the former, minimizing the overall effect on your portfolio.
Consider liquidity in your investment choices
Liquidity refers to how quickly you can convert an investment into cash without loss of principal. Generally speaking, the sooner you’ll need your money, the wiser it is to keep it in investments with comparatively less volatile price movements. Therefore, your liquidity needs should affect your investment choices.
Dollar cost averaging: doing it consistently and often
Dollar cost averaging is a method of accumulating a portfolio by purchasing an investment at scheduled intervals over an extended time. Remember that, just as with any investment strategy, dollar cost averaging can’t guarantee you a profit or protect you against a loss if the market is declining. To maximize the potential effects of dollar cost averaging, you should also assess your ability to keep investing even when the market is down.
An alternative to dollar cost averaging would be trying to “time the market,” in an effort to predict how the price of real estate will fluctuate in the months ahead so you can make your full investment at the absolute lowest point. However, market timing is generally unprofitable guesswork. The discipline of regular saving is a much more beneficial strategy, and it takes no mental effort or study.
Review your portfolio and game plan: buy and hold, don’t buy and forget
Unless you plan to rely on luck, your portfolio’s long-term success will depend on periodically reviewing it. Even if nothing bad at all happens, your investments will appreciate at differing rates, so after a while, your asset allocation mix will change. Rebalancing involves restoring your original asset allocation decisions by shifting your funds among investment classes to restore the ratios you decided on in first designing your portfolio.