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New to investing? You probably have some basic questions you need answered before you’re fully comfortable getting started. That’s completely normal.
First off, you don’t have to be on Wall Street to succeed as an investor. (You don’t have to know The Next Big Stock, either.) However, there are a few rules of thumb that can help all degrees of investors, including beginners. Yes, all investing involves risk, but these tactics and lessons could better prepare you to reach your goals.
This might seem like a basic step, but too often people will save — or in this situation, invest — without a goal in mind. Outlining your investment goals will help you come up with a far better plan for reaching that goal than if you aimlessly contributed money to an investment account every once in a while. For example, if you’re hoping to buy a home in five years with a down payment of $20,000, that plan will differ greatly than if you had 10 years to buy that same home.
Plus, think of it this way: When you know what you’re saving for, you’ll probably be more motivated to contribute additional funds to your investments than an arbitrary goal of having money for the future. It also allows you to monitor your progress.
Need help identifying your risk tolerance? A lot of it’s based on emotion. Are you comfortable experiencing large fluctuations in performance? Or will such a portfolio keep you up at night?
As mentioned before, investing — by nature — involves risk. But with that risk comes the prospect of higher returns, which is why people invest rather than stash money in safe, lower-yielding savings accounts.
At the same time, the potential for loss is why investing in the stock market is typically suited for goals that are at least five years out. Generally speaking, the longer your investment window, the more risk your portfolio can withstand since — in theory — you’ll have the time to overcome dips in performance. Keep in mind you can modify your portfolio’s exposure to risk as you get closer to your goal.
Also, consider the type of goal you’re attempting to achieve. Is it a need like supplementing your child’s college savings? It’s probably worth taking on lower risk for something like that (particularly as high school graduation approaches) than something that’s a want or wish, such as a sports car. For those, you might decide to “go for it” by having a higher exposure to stocks (also known as equities) knowing it’s not absolutely critical you reach the goal at all, let alone by a certain date.
Once you decide on your ideal level of risk, you can construct your portfolio accordingly. Portfolios with longer investment windows tend to have higher exposure to stocks. Meanwhile, portfolios with shorter horizons typically have higher exposure to bonds.
When constructing your portfolio, consider diversifying across multiple asset classes to cushion against risk. For example, stocks and bonds tend to work in different directions, which can limit fluctuations in performance. Even aggressive portfolios tend to have a small allocation of bonds. You could even further diversify within a specific asset class, such as stocks that are national and international, or small and large.
So, how do you decide the appropriate asset allocation between stocks and bonds? A common rule of thumb is to subtract your age from 110. The difference between the two could be used as an indicator for the percentage of stocks in your portfolio. For example, if Ben is 35, his portfolio could have 75% (110-35=75) exposure to stocks and 25% to bonds. (Previously, the rule of thumb was to subtract your age from 100. However, now that people are living longer, some have shifted to using 110 or 120 to help their money last longer.)
Waiting until just the right time to begin investing? Don’t overthink it. Timing the market is very difficult to do, even for the savviest investors. When you begin investing comes down to one thing — you.
Some people might wait for the market to dip to get started; others will wait for a strong market in the hopes they can “get in on the action.” Instead, wait for the right time in your life to start investing, not the right time in the market.
Trying to time the market could result in missing out on some of the top performing days in your investment window. For example, the chart below shows the return on a $10,000 investment in the S&P 500 from January 2, 1996 and December 31, 2015:
If the investor held out in an effort to time the market, they could have missed out on some or all of the 10 best performing days. That could be the difference of an extra $24,160 of return. You won’t know when those best days will come in your investment window; in fact, six of those 10 best days in the example above occurred within two weeks of the 10 worst days.
If you’re new to investing, try to resist the temptation to run at the first sign of “trouble.” Performance ebbs and flows. It’s unlikely that you’ll experience consistent returns each year on the path to your goals. Instead, the focus should be on reaching your target amount by the end of your investment window, not what happens in between.
Consider the stock market crash in 2008. Those who pulled their money out of the market during the crash experienced heavy losses. Meanwhile, those who stayed the course recovered rather quickly, generally speaking.
It’s best to play the long game. It’s truly a marathon, not a sprint.
For some, investing involves uncertainty. How do I know I’ll reach my goals? Will I be able to withstand a market correction? These questions are why it’s so important to have a plan. Then you can go back and make any necessary changes as you go through your life.
Investing can be a helpful method of planning for the future, whether it’s your retirement or any other financial goal. To learn how we can help you invest for the future, visit us online or schedule a Citizens Retirement Checkup® at your nearest Citizens Bank branch.
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