Not everybody wants to be a sophisticated investor who is well versed in technical analysis and can figure out ways of the markets. It is actually very difficult even for the pros who make living investing other people's' money.
What ordinary people like you and me with a day job and a family need is smarter ways of investing. One thing I have learnt through my investing experience is to keep investing very SIMPLE.
There are very simple rules you can follow if your goal is to get good returns at a reasonable risk. Remember, investment goal should not be to become rich overnight, but to get the returns that will accumulate wealth slowly but steadily over a long period of time, hopefully through the working career.
How do you invest smartly to get a decent amount of returns? Follow these simple steps.
Make A Plan
When you become serious about retirement investing, first come up with a plan. Without a plan, it is impossible to know whether you are on the right track or not. Your plan needs to document investment goals, your retirement horizon, your risk tolerance, and the mix and percentages of the assets you want own in a portfolio.
In your plan, document goals in two broad categories, short-term goals such as down payment on a house or a car and long-term goals such as kids' college fund and your retirement fund. To achieve these goals, you would need to calculate how much money you would need to save for these goals. Start putting money for short-term goals in safe assets such as CDs, money market funds, treasury bills. Put money for your long-term goals in stocks, bonds, and REITs.
Diversify
Don't put all your eggs in one basket. Invest in broad-based quality securities such as index funds that will capture the returns of the entire markets. When you have built a diversified portfolio of funds, don't try to beat the market. Don't try to time the market. Save regularly. Stay invested at all times.
Get Emotions Under Control
Investors are often their worst enemy. Emotions often get in the way. One simple rule I follow is this: don't be greedy and don't give in to fears.
Fear causes to people to become excessively risk-averse. During 2008-2009, people pulled their money from the stock markets and put it in the safe assets like money market funds or CDs. After 2009, when the market recovered, many people didn't get back in until late 2012 or 2013 after seeing big gains in those two years.
Excessive greed is just as dangerous. Lots of people over-bought the overvalued dot com stocks leading up to the dot com bubble in the late 90s. When the bubble popped, many of the dot com companies shut their doors. The value of these companies wasn't what most investors paid for. Greed causes people to get in and out at wrong times.
Invest Regularly Through Dollar Cost Averaging
Dollar cost averaging is a good way to tamper emotions. Suppose, you just got a big bonus of $20,000. You are reluctant to invest because this is a big amount and you fear worse could happen to the stock markets. What if the market collapses after you just invested the money? That would be a major blow to your investment. But, if you split that $20,000 into 10 chunks of $2,000 each and invest regularly at the beginning of every month for the next 10 months whether the market has gone up or down, that creates a system that mitigates regret and forces emotional self-control.
I have followed this system since 2008 and have stayed invested in the stock markets during all these years. The result is a lowered average cost of the shares purchased through the downturns. Another benefit of this system is that I don't think twice about whether today is a good day to invest or not. Because of this system, all my investments are automatic and happen every day of the week without my intervention.
Keep Things Simple
It is very easy to get drunk on the wealth of choices available and end up with an unwieldy portfolio made of scores of stocks and mutual funds. Investors with such a wide array of portfolio holdings think they are well diversified and insulated from the market downturns. Unfortunately, too many choices lead to overlapping of market slices. Additionally, too many choices will add trading costs. Not to mention more time will be required to research the securities. This is why you need to keep your portfolio simple.
One of Warren Buffet's tenets is to "never invest in a business you can't understand". Anyone who had followed this advice was spared during the great recession. In general, ordinary folks should stay away from complex securities such as collateralized mortgage debt instruments, commodities, options trading, principal protected securities, insurance products, funds that seek to double or triple index's gains, and funds that track obscure volatile indexes.
Make sure you understand what investments you have in your portfolio and why you have it. If you can't reason why something is there in the portfolio, then you may want to reconsider switching it with another investment that you can justify its existence.
Conclusion
If you follow these simple rules, the market will reward you handsomely when you retire. Most people abandon these steps when the going gets tough. But, that is where smart investors make most of their money. Treat volatility and market downturns as a blessing in disguise. It is a time to load up on clearance priced stocks and mutual funds and certainly not a signal to sell. If you stick with your plan and stay diversified, half of your battle is over. Let the markets do the rest of the work and keep patience. Remember, investing is not a sprint, it is a marathon.
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