Ten Tips That Will Help You Make Great Investment Decisions, by Rick Viader
The Office of Investor Education and Advocacy, a subdivision of the U.S. Securities and Exchange Commission (SEC), provides tools and services that can help solve investment problems. As part of its duties, the agency recently issued an Investor Alert to provide investors with investment tips to help them navigate the current economic situation. For all investors who wish to add to or remove from their existing investment portfolio or those new to the investment world, these tips can help investors make better decisions.
The agency also hopes that these tips will stop many investors from making rash investment decisions that only benefit them in the short term. It stated that this had been the trend with many investors who are panic buying or selling because of the current economic situation. Here are some tips to help make an informed decision.
Have a Plan
Every big decision requires a solid, fool-proof plan. Investing is no different. The first tip in the Investor Alert underscores the importance of drawing up a financial plan before making any drastic decisions. Investors need to carefully consider every part of their financial situation, including their goals and risk tolerance level. You can consult a seasoned financial advisor if you do not know how to go about this. The Office of Investor Education and Advocacy also states that an intelligent financial plan, which involves adequate knowledge of savings and investments, can lead to financial independence and security in the long term.
Know Your Risk Tolerance Level
One common thing with all forms of investments is the risk of losing money. This factor is one that some investors tend to forget. When such investors make losses, they immediately become disheartened and either pull out their money from other investments or give up on investments entirely. To avoid falling into this category and missing out on all the great benefits of investing, you must carefully analyze your risk tolerance level and make investments in line with it.
Investors that wish to invest in debt securities, such as bonds, equities and mutual funds, should know that something and everything can go wrong. Debt securities are uninsured investments, unlike savings accounts that have the guarantee of the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Association (NCUA). Even if you purchase your investments through reputable financial institutions, you could still lose all or a part of the invested money.
You can avoid this unpleasant situation when you make investments in line with your risk tolerance level. All investors should also note that with bigger risks come higher returns. Investors who wish to invest in the long term need to make larger investments involving more risk. These investments, such as stocks and bonds, generally have higher returns. If your financial goals are short-term, you may want to invest more in cash equivalents. Such investments have lower returns and risks. However, as long as you do not keep them too long, you should achieve your short-term financial goals. If you hold cash equivalents for too long, inflation could drastically reduce the value of your investments.
Mix it Up
Your investment portfolio should contain a mix of asset categories with returns that fluctuate with market conditions. Doing this can protect your investments from significant losses during economic downturns. For example, the three major asset categories, i.e., bonds, cash, and stocks, have always recorded varying interest rate fluctuations. When one gets high returns, another gets medium or low returns. Investors who have all three in their portfolios are more likely to have some form of mitigation against losses. For instance, if market conditions are unfavorable for bonds, investors will be able to balance out the effects using the gains from cash or stocks.
The Investor Alert also points out the importance of asset allocation, a process whereby investors divide their investment portfolio among different asset categories. A good allocation of assets is usually the first step towards achieving your financial goals. To achieve this, investors must take on risky investments that have higher returns. This step is especially important for investors saving long term for a financial obligation, such as retirement. If you are in this category, experts advise having stocks or stock mutual funds in your portfolio as well.
If mixing it up would be too difficult for you, or you would rather just put your money in one form of investment, you should consider investing in lifecycle funds. Lifecycle funds help investors prepare for a long-term financial obligation by moving towards less risky asset categories as the obligation draws closer. If you wish to invest in lifecycle funds for a goal or need, you can pick a fund with a similar target date as your financial goal or obligation. Lifecycle funds have managers who oversee the funds’ diversification, asset allocation, and investment methods so that investors can be at rest.
Go Easy on Employer Stocks and Individual Stocks
There is no room for sentiments or emotions when it comes to investments. If you are putting your money in your employer’s stocks, ensure that you have your facts right and you are not putting all you have in that one basket. If things do not go as planned, not only will you lose your investments, you might also lose your job. Likewise, you should also be wary of putting all your money in the stocks of an individual company. If anything happens to the company, you will lose all of your money.
On the other hand, if your investment portfolio is diversified, you will have something to fall back on if anything goes wrong with one or two of your investments. A diversified investment portfolio contains a little bit of everything instead of focusing on one thing.
Save for Emergencies
Emergencies will happen. Your car will suddenly need fixing, your roof might start leaking, or something could go wrong at work. If you have a savings account for emergencies, you will be able to take care of these problems without worries. The Investor Alert suggests that investors should save six times their monthly income for emergencies.
Ensure You Take Care of Your High-Interest Credit Card Debts
Whether the market is good or not, it is always good to be free of high-interest debts. The longer you hold off paying off these debts, the more money you have to pay. Even if the market is so bad that you are not making gains, you shouldn’t be making heavy losses. Avoid this by paying off your high-interest debts as soon as possible.
Use “Dollar-Cost Averaging†to Get the Best in all Market Situations
Dollar-cost averaging is an investment strategy where investors periodically invest in a target asset using a fixed amount. If the price is low, they buy more of the asset and buy less if the price is high. This way, they do not invest too heavily when prices are up or the market is down. The Investor Alert especially calls on investors who invest lump sums at the end of the calendar or fiscal year to use the dollar-cost averaging strategy, especially during economic downturns.
Use All the Free Money You Can Get From Employers
Many people pass up the opportunity of the free money they could get in retirement plans that employers sponsor. In many of these plans, employers match a percentage or all of what the employee contributes. If your employer offers such plans, you should save as much as possible to get their maximum match.
While on the subject of employer-sponsored retirement plans, it is essential to address some mistakes people make about 401(k) accounts. The plan is a retirement plan, and naturally, it frowns on borrowing. Except when it is absolutely necessary, avoid borrowing from your 401(k) savings. If you have trouble doing this, you might want to discard your 401(k) debit card. The more you borrow from the account, the harder it gets to build your savings for retirement. You might even have to pay penalties if you cannot repay the loan.
Regularly Rebalance Your Portfolio
Over time, it is easy to stray from your original asset allocation mix. As you shuffle things around, you may be putting too much in one asset category and too little in others. The way out of the problem is periodic rebalancing. Rebalancing will help you regularly diversify so your money is not too concentrated on one asset category. It will also help reduce the risk level of your portfolio.
Another trick is to always buy low and sell high. The point at which an asset is doing poorly is the time to buy more, hoping that the prices will rise and you will make your money in multiple folds. Though it might be challenging to sell asset categories that are performing excellent than to buy those that are not, it could benefit your portfolio if correctly done. Rebalancing can, however, help achieve this.
There are two tricks to rebalancing. You can make it periodic based on the calendar or rebalance it when your investments exceed or fall below a previously designated limit. The Investor Alert states that financial experts advise investors to rebalance once or twice every year for the first method. If you choose to do this, a simple calendar reminder will let you know it is time to rebalance your portfolio. Investors who choose to use their investments simply need a price increase or drop, as the case may be, to start the process. Lastly, the Investor Alert states that rebalancing is best down on a comparably irregular basis.
Watch Out for Fraudsters
The Investor Alert also warns investors to look out for scam artists who use highly publicized news items to steal from innocent people. They present “legitimate†schemes using these news items, and investors who put in their money because “they heard it from the news†will be defrauded. To know if a scheme is legitimate, the SEC recommends getting satisfactory answers to these questions. The agency also advises investors to seek professional counsel and talk to friends and family members to avoid falling for the wrong scheme.
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