Investing can feel intimidating, especially for new investors. However, even small amounts invested consistently over time can grow through the power of compounding.
Tune out the noise and stay confident in your established investment plan. Market fluctuations are normal, and worrying about them won’t do much good. Instead, focus on rebalancing your portfolio periodically.
Know Your Risk Tolerance
Whether you invest on your own or work with a financial professional, knowing your risk tolerance is one of the most important factors in crafting an investment strategy. This is your comfort level with the possibility of losses in your investments, and it can affect your ability to weather market volatility.
You may be someone who embraces investment risk for the potential of a higher return or you may be more comfortable with lower returns in exchange for peace of mind. Knowing your risk tolerance can help you and your advisor determine how much of your portfolio should be in stocks or bonds, for example.
Your investment time horizon can also impact your risk tolerance. If you are saving for a goal that is decades away, like retirement, you can typically afford to take on more risk since you will have plenty of time to recover from market downturns. Alternatively, if you are investing for a goal that is just a few years away (like a down payment on a home), you might want to opt for more conservative investments.
It is also helpful to regularly reassess your risk tolerance. This is especially true if your life changes, such as a new job or marriage, or if you reach a new financial milestone, like becoming a parent.
Diversify Your Portfolio
Investing is all about risk and return, but diversification can help smooth returns and reduce the risk of loss. A well-diversified portfolio includes different asset classes – stocks, bonds, real estate, and commodities – that have varying levels of risk.
The diversified assets in your portfolio can also differ in size, style, and geography. Not all stocks perform well at the same time, so spreading your stock holdings among small and large caps, domestic and international markets, and growth and value styles can help to lower the risk of an overall stock decline. Likewise, you can reduce the risk of a bond portfolio by putting some money into a mix of maturities and credit qualities and by including a modest allocation to alternative investments.
Diversification can’t eliminate risk or guarantee returns, but it can help you feel more comfortable with market fluctuations and may bring you closer to achieving your investment goals. With proper planning and frequent rebalancing, you can create a portfolio that is in line with your risk tolerance and investment objectives.
However, it’s important to note that if an addition to your portfolio increases its overall risk without also reducing the expected return, it is likely not serving its purpose of diversification. This can occur when there are already more than an ideal number of securities in your portfolio or when you add closely correlated securities that tend to move together.
Know Your Goals
Having clear investment goals can help you decide what type of investments to pursue and how much to contribute toward them. The goal-setting process can also help you determine your financial priorities and provide a framework for setting other investment strategies.
Start by outlining your short- and long-term financial goals, such as saving for a vacation or a new car, buying a home, or funding retirement. Identify the cost of each goal and the timeline you need to achieve it, as these factors will dictate the appropriate amount of risk to take in your portfolio.
Remember that the purpose of investing is to build wealth, not get rich quickly. While the occasional large gain may entice novice investors, the majority of successful long-term investor returns come from small, regular contributions over time. Avoid trying to beat the market by chasing hot stocks or funds, and don’t be fooled by those who promise you they can “get you rich on tips.” Investing based on those types of recommendations can leave you vulnerable to economic cycles, and even a single ill-advised tip can wipe out your entire portfolio.
A diversified portfolio of different asset classes, regions, and sectors mitigates losses from specific market movements and maximizes overall long-term returns. It also helps to keep you emotionally stable during turbulent times, a trait of successful investors.
Don’t Be Afraid to Ask Questions
Investing successfully is a process that requires setting goals, taking informed actions and balancing risks. It also means being open to learning from mistakes – because no one gets it right all the time.
The most important step is to ask questions – to yourself and others. Asking the right questions is critical for making the best investment decisions. Whether it’s about an opportunity or an existing investment, asking the right questions is the only way to ensure that you’re evaluating all of the information available and aren’t being taken advantage of.
For example, when examining a potential investment opportunity, it is important to not just look at the company’s P/E ratio but also consider things like its operating margin, its cash flow growth, management competence and sustainable competitive advantages. You should also make sure that the investment matches your own personal investing goals.
Finally, when considering any investment opportunity, you should be able to clearly understand how it works and who is behind the opportunity. This is especially important if the investment promises returns that seem too good to be true – they very well might be.
Every investment carries some risk, but if the risks keep you up at night or cause you to lose sleep then it’s probably not the right choice for you.