The Difference Between Failure and Success is as Simple as PDQ
The PDQ Principles of investing: Patience, Diversification and Quality. In my mind, these are an investor’s foundation, supported by several principles that play key roles in your retirement savings plan. Even with them, it's a rocky road. Without them, you’ll be roaming in the wilderness without a compass. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
Over the years I've learned - and preached - the value of simplicity. It helps you avoid the clutches of financial Wazoos…those wizards who bombard investors with a myriad of complicated services and/or products that, like Houston’s Mattress Mac is quick to profess, “Will save you money!” The Wazoos also claim they will "make you money” or “grow your money” using some complicated formula. But as with most aspects of our lives, everything has a price. Too often, the price of complexity is our time and often our peace of mind – in addition to the Wazoo’s fees.
The quickest route to effective diversification is to invest in mutual funds rather than spend the time-consuming effort to properly research dozens of stock. An important place to start mutual fund investing is to build a diverse portfolio around an index fund. In my own case, I started with a Total Stock Market Index Fund, which exposes an investor to the entire U.S. equities market (an array of large as well as mid-size and smaller companies).
Another “seed” fund could be the also highly-diversified 500 Index Fund (which provides exposure to 500 of the largest U.S. companies by valuation). If used, the 500 fund should be counterbalanced with an aggressive growth stock fund. In either case, by initially focusing on such highly-diversified funds, you automatically avoid exposure to too much risk, while at the same time avoiding too little risk. Risk, of course, is part of investing and impossible to avoid except by degree. By definition, investing in mutual funds helps reduce risk, but not entirely.
By taking the index fund route, you avoid – in my opinion – developing the questionable habit of trying to time the market
This Ain't it, Chief
It matters not how sophisticated you are or how sophisticated your particular approach to investing is, attempting to time the market is a losing proposition. Just remember that most market gains happen on very few trading days. Corrections are normal events in the investment world and are often followed by some of the best days in markets. If you are not invested during those few days you'll miss valuable money-making opportunities. In short, remain invested at all times.
There are a few more important rules of thumb to know – also called common sense – if you want to optimize your investment yield over the long-term. At the top of this list is to keep costs low (a reason I love dealing with Vanguard). For example, saving fractions of a percent in net operating costs over the long term can make a huge difference, particularly when magnified by the amazing power of compounding. And, pay attention to the tax impact of each investment decision along the way. Minimizing taxes is simply another way to help optimize yield over the long-term…better your gain than Uncle Grabby’s.
A primary way to minimize taxes in the absence of CPA skills is to exercise patience. While experiencing those many market corrections along the way, don’t head for the exits. Exercise patience…stay the course…whatever you wish to call it…but have faith in the quality of your investment selection process. Many corrections are Baby Bears but can still be just as nerve-wracking as the Big Bad Bears.
Save That Bread
Don't sell quality investments during a market correction, unless of course, you need cash. When you do sell, three things often work against you:
One, you’ll either trigger an unnecessary taxable capital gain on the sale.
Two, you’ll lock in an unnecessary “real versus paper” loss on a quality product that would most likely recover once the correction subsides.
Three, if an investor exits the market, he or she must later decide when to buy back in, a timing issue, which one hopes to avoid as a buy-and-hold participant. As a consequence, many investors suffer “opportunity costs” by re-entering the market after it has substantially recovered much of what it lost during the correction. In many cases, those who sell into the chaos never re-enter the market because of the bad experience.
No Cap, Fam
Even with a good investment plan, unless you adhere to routine habits of saving and investing, you’ll still be somewhat adrift.
So, in sum:
By necessity, you must SAVE…particularly, once you have “earned income”.
Create a Roth IRA, which requires the aforementioned earned income.
Invest all or a portion of those savings (without fail every month) in an Index Fund, preferably a Total Stock Market Index Fund.
Exercise patience during the market's many ups and downs.
Don’t stop saving and investing until you retire.
To young and/or experienced investors: This strategy can be the difference between both short- and long-term success and failure in the quest for financial security related to child-rearing, college expenses, and ultimately, retirement. No cap.