7 Rules of Investing That You Should Know
Some people think that investing is about luck — and to some degree, it is. After all, you’re putting your money into a company and expecting it to increase in value over time, with no way to know what the future holds for that company, the industry or even the economy in general.
But there are ways to improve your luck in investing, and therefore increase your chances for success. Here are seven rules of investing that you should know.
What Are the 7 Rules of Investing?
Investing in the stock market is never a sure thing, but understanding and adhering to these investing principles may tip the scales in your favor:
- Start early.
- Only invest what you can afford to lose.
- Buy what you know.
- Diversify your portfolio.
- Don’t try to time the market.
- Watch out for fees.
- Be a contrarian.
1. Start Early
It doesn’t matter if you start small, as long as you start early. Through the magic of compound interest, investing early and regularly will give you the greatest returns, even as the market goes up and down. As your income increases and you are able to invest more, increase the amount you put into your investment account, but start by investing what you can right now.
That said, you can’t start any sooner than today, so don’t beat yourself up for not starting earlier. Start now and invest a small amount every month.
2. Only Invest What You Can Afford To Lose
No one invests with the goal of losing money, of course, but it does happen. There are no guarantees in the stock market, so make sure that losing your investment won’t negatively impact your ability to cover your regular monthly expenses.
Set aside some money each month to add to your investment account. You should view this as a regular monthly expense, like your mortgage or utility bills. Make it a line item in your budget.
3. Buy What You Know
Legendary investor Warren Buffett adheres to this rule, and it’s hard to argue with his success. When you invest in a company, you become an owner, so it’s important to think like an owner. To do this, you need to understand what the company does, who its customer base is and what other companies it competes with. If you can’t understand the offering or the industry, find another company to invest in.
Your own experience is also a good place to find investment recommendations. If there is a product or service that you use because it is the best in the business, why not invest in the company that provides it?
4. Diversify Your Portfolio
Investing everything in a single sector or even — heaven forbid! — in a single company is incredibly risky. Including investments from various sectors as well as various asset allocation classes is the way to go. Your portfolio should include small-, medium- and large-cap companies and both growth and value stocks. The weight each of these classes has in your overall portfolio may vary, but you should have a lot of variety.
Diversification is not a one-and-done proposition. You need to review your portfolio regularly to ensure you remain properly diversified. If one sector outperforms all the others, you’ll find yourself too heavily weighted in that sector. This is fine as long as the sector continues to outperform, but that’s usually not the case. Eventually, that sector will likely pull back, and you’ll be overexposed.
Note that diversification involves your entire investment portfolio, so if you hold stock in the company you work for, you’ll want to factor that into the mix as well. In other words, if you work for a tech company and have company stock, that may well be as much tech stock as your portfolio can handle. So don’t forget to include it when you’re choosing your investments.
5. Don’t Try To Time the Market
The most successful investors realize that they are in it for the long haul. While it’s important to watch your investments closely and buy and sell based on each company’s prospects, timing the market rarely works out.
Those who try to time the market will, theoretically at least, pull their investments out and move to cash when the market declines, and then reinvest when the market begins to move upward again. The risk here is that it can be difficult — if not impossible — to differentiate a market trend from a blip. It’s hard to know when a market downturn will continue, so market timers often end up getting out after their positions have already begun to decline, thereby locking in their losses. Knowing when to get back in is equally challenging, and the market timers will often get in on the upside too late, missing out on the biggest gains.
6. Watch Out for Fees
The last thing you want, after putting in all the work to choose the stocks most likely to provide a positive return, is to watch your gains evaporate because you’re paying fees. You can manage your own portfolio in a commission-free online account and avoid per-trade fees. Or, you can have someone else manage it and pay them a fee, which is typically a percentage of your account balance. If you do this, you want to ensure that the expertise of the manager produces returns that justify the fee, or that the time saved by not doing it yourself is worth the fee.
7. Be a Contrarian
Another of Warren Buffett’s truisms is to “be fearful when others are greedy, and be greedy when others are fearful.” In a bear market, there are buying opportunities if you are observant and patient. Buying when everybody else is selling can be a great money-making strategy.
