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Monday, November 28, 2011
How to Become a Good Investor
1. First of all, determine whether you should be investing at all. If you have any debt other than a home mortgage your first priority should be paying off that debt. It doesn't make sense to pay more in interest than you earn on your investments. The only exception to this is investing for retirement or education in a tax sheltered account like an IRA, 401K or 529 plan. Since you are getting a tax benefit it always makes sense to invest in them if you can spare the money.
2.A good investor always pays himself or herself first. Examine your monthly budget. After you take out what you need for essentials like food, shelter and utilities how much is left? Decide what you can afford and invest that much every month just like it is another bill. If you get a raise or a bonus invest it as if you never laid your hands on it. Also, avoid debt at all cost. Don't buy things you can't pay for immediately. Debt is the opposite of investing.
3.Now that you have gathered some money to invest, it's time to decide what to do with it. It all depends on what you will eventually need that money for. If you are saving to buy something big in a year or two then your investment should be conservative. If you wont need your money for at least five years you can take more risks. If you are saving for a child's education or retirement that wont happen for more than a decade then you can afford to be aggressive. The more aggressive an investment is the more likely it will grow in the long run. It is also more subject to wild swings up and down. If you can ride these out over time you should be fine. If you suddenly need money from an aggressive investment it may be worth much less than you initially put in. Knowing your time horizon will help you avoid such mishaps.
4.Most investors save money for several different reasons. They put away a little for retirement, a little for house down payment, a little for a big vacation next year. This is a sensible approach. Divide your investment dollars into three piles. One for short, one for medium and one for long term investments. How big each pile is depends on your priorities. The medium pile doubles as an emergency fund in case you lose your job or have a big unexpected bill.
5. Long term investments should take advantage of tax benefits. If your employer offers a 401K plan invest all you can afford in it. Your money is not taxed which makes it worth more than if you got it in your paycheck. Some employers also match some of your contribution. That's free money! An IRA is another good option if you don't have access to a 401K plan. They also offer tax benefits. 401K's and IRA's are long term investments so should be in aggressive funds like growth stocks. Put away a little money every month and you will live comfortably in retirement.
6.Most medium and short term investments will involve accounts that require you to pay taxes on your gains. Your goal should always be to pay as little tax a possible. If you buy stocks try to hold on to them at least a year. You pay less tax on gains that way. If you lost money you can deduct some of the losses from your taxes. Stocks are more risky than bonds which are more risky than cash investments. In general stocks change in value but you don't actually get a gain or loss until you sell them. In general bonds pay a dividend periodically which acts like income and their value fluctuates less. Cash investments include money market accounts and certificates of deposit you get at the bank. They wont fall in value but pay less in interest. They are the most conservative investment.
7.Your portfolio is the culmination of all your investments. A well balanced portfolio should be a mixture of stocks, bonds and cash. If you are young and wont need the bulk of your money for a long time, your portfolio should be heavy in stocks. If you are approaching retirement or will need a lot of your money within a few years, you should be heavier in bonds and cash. A portfolio grows unevenly so periodically examine it and adjust the proportions to suit your investment plan. As you grow older, your plan will change. There are mutual funds that will do all this for you. All you do is tell them when you plan to retire. The key is to make a plan and stick to it. Investing isn't hard but it does require discipline and commitment.