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Top Investing Rules You Need To Follow

1. Clarify the purpose of your money.

There’s one rule of investing that you should always remember: Never expose money to more risk than is necessary to accomplish your goals. So, take a step back and be clear about why you’re investing in the first place. Determine when you’ll need to spend the money you plan to invest, because that determines what you should do with it.

Historically, a diversified stock portfolio has earned an average of 10%. But even if you only earned an average of 7% on your investments, you’d have over $1.3 million to spend during retirement if you invested $500 a month for 40 years.

But if you save $500 a month in a bank account with an average return of 0.5% over 40 years, you’ll only accumulate about $250,000. So, if your long-term goal is to have a nest egg that allows you to pay for retirement, keeping money in a safe place—like a savings account or a low-yield CD—simply won’t get you there.

The reality is that not taking enough investment risk can be the riskiest move of all! You could fall short of your goals or run out of money during retirement.

If there was no risk to getting a big return on your money, everyone would run to the highest-yielding investments. But high return investments usually bring higher risks, so they need to be used carefully.

In other words, investing means that you could possibly lose money. This risk creates a tension that keeps many people from getting started investing in the first place.

Also, consider that in the past couple of years, the inflation rate has been more than 2%. So, if you’re not earning at least that much, you’re really losing money.

Therefore, taking calculated investment risk is an important part of your financial life. Without it, your money won’t grow fast enough to achieve your long-term goals. Keeping money safe and cozy in a low-interest savings account stunts its potential and doesn’t give it the opportunity to grow.

The reality is that not taking enough investment risk can be the riskiest move of all! You could fall short of your goals or run out of money during retirement. Whether you avoid risk intentionally or have simply been procrastinating investing, the result could be devastating to your financial future.

2. Know the difference between saving and investing.

Though we tend to use the terms saving and investing interchangeably, don’t confuse them. Here are the major distinctions between the two:

  • Saving is putting money aside without exposing it to any or little risk, such as in a savings account, money market deposit account, or a certificate of deposit (CD).
  • Investing is committing money to an endeavor or account with the expectation that you’ll make a certain amount of profit or income. The risk is that you’ll receive less than what you expect. Or worse yet, there’s a possibility that you could lose your entire investment.

As I mentioned, the timing for spending money determines what you should do with it. Money that you want or might need in less than five years should not be exposed to market volatility because it’s value could drop at the exact moment you need it.

So, even though safe, low-yield options—such as a bank savings or a money market deposit account—are poor choices for your long-term goals, such as retirement, they’re perfect for your short-term goals and emergency savings.

Money that you want or might need in less than five years should not be exposed to market volatility because it’s value could drop at the exact moment you need it.

Before you do any investing, your first financial priority should be to accumulate emergency savings. That’s how you avoid getting into financial trouble if you have a large, unexpected expense or lose your job or business income.

Ideally, everyone should have a minimum of three to six months’ worth of their living expenses tucked away in an FDIC-insured bank savings account. If that amount seems unattainable, start by saving a reasonable amount, such as $500 or $1,000. Then build it while you invest for the future at the same time.

The ideal scenario is to invest a minimum of 10% to 15% of your gross income for retirement, plus an additional 10% for emergency savings. Consider these amounts monthly obligations to yourself, just like a bill with a due date you receive from a merchant.

If saving and investing a minimum of 20% of your gross income seems like more than you can afford, start tracking your spending carefully and categorizing it. I promise that when you see exactly how you’re spending money, you’ll find opportunities to cut back and save more.

Let’s get back to the anonymous question about having $50,000 sitting in a savings account. Whether you should move some amount into investments depends on how much emergency money you need.

If you feel comfortable having less on hand, you could use some of it to max out an IRA. For 2018, you can invest up to $5,500, or $6,500 if you’re over age 50, in a traditional or a Roth IRA. Or you could leave the savings alone and begin making contributions to a retirement account.

3. Start early and small.

One of the most important factors in how much wealth you can accumulate depends on when you start investing. There’s no better example of how the proverbial early bird gets the worm than with investing.

Starting early allows your money to compound and grow exponentially over time—even if you don’t have much to invest. Compare these two investors, Jennifer and Brad, who set aside the same amount of money each month and get the same average annual return on their investments:

Jennifer

  • Begins investing at age 35 and stops at age 65
  • Invests $200 a month
  • Gets an average return of 8%
  • Ends up with just under $300,000

Brad

  • Begins investing at age 25 and stops at age 65
  • Invests $200 a month
  • Gets an average return of 8%
  • Ends up with just under $700,000

Because Brad got a 10-year head start, he has $400,000 more to spend in retirement than Jennifer! But the difference in the amount Brad contributed was only $24,000 ($200 x 12 months x 10 years).

So never forget to start investing as early as possible. It’s a huge mistake to believe that you don’t earn enough to invest and can catch up later. If you wait for a windfall, you’re burning precious time.

So never forget to start investing as early as possible. It’s a huge mistake to believe that you don’t earn enough to invest and can catch up later. If you wait for a windfall, you’re burning precious time.

Remember that investing early is like getting a healthy retirement nest egg on sale! It’s one of the best financial habits you can develop, even if you can only put aside small amounts on a regular basis.

Even saving or investing just $20 a month is better than nothing. And if you’re starting late, don’t stress about it—just get motivated to start right now. For most of us, building wealth is a slow journey that involves putting small amounts of money aside on a regular basis.

Setting up your accounts and automating contributions is a powerful step in the right direction. Years from now when you’ve got savings and investments to fall back on or to fund the lifestyle of your dreams, you’ll be so happy that you took control of your financial future.

4. Don’t try to beat the market.

While it might sound boring, you should aim to be an investor who makes average returns. That’s because chasing high returns, reacting to short-term market volatility, and buying into media hype generally doesn’t work.

Investors think their choices must be right if other people are doing the same thing. The media says buy, so most investors get in the market. And when everyone else is in a panic and selling, that’s what most people do. When you invest emotionally you could end up buying high and selling low, which is the exact opposite of how you make money.

Yes, short-term investment returns can vary dramatically from day to day and month to month. But over the long term, market returns always revert to the average. So, stick to a long-term, buy and hold investment strategy for funds you won’t need to spend for at least 10 years.

See also: Are You Making Investing Too Complicated?

5. Be diversified to cut risk.

Many people are surprised to learn that it’s better to own more investments than less. This is a proven investing strategy called diversification. It allows you to earn higher average returns while reducing risk, because it’s not likely that all your investments could drop in value at the same time.

Diversifying doesn’t increase investment returns all by itself. But it does allow you to reduce investment risk, and give you more safety and control, without lowering your return.

For instance, if you put your life’s savings into one technology stock and it tanks, you’re in trouble. But if that stock only makes up a fraction of your portfolio, the loss is negligible. Having a mix of investments that respond to market conditions in different ways is the key to smoothing out risk.

For most investors, who don’t want to make a career out of stock picking, buying individual stocks is a bad idea. It’s risky because stock prices can be volatile and fluctuate wildly. Trying to find one or two winning stocks is gambling, not smart, strategic investing.

But it’s easy and affordable to build a diversified portfolio by purchasing shares of a low-cost mutual fund or an exchange-traded fund (ETF). Funds bundle combinations of investments in stocks, bonds, assets, and other securities into packages that are convenient to buy because they’re made up of many underlying investments.

Diversifying doesn’t increase investment returns all by itself. But it does allow you to reduce investment risk, and give you more safety and control, without lowering your return. If the price of one stock in a fund takes a dive, it’s no big deal because you own hundreds or thousand

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