You’ve heard it before: Don’t let emotions get in the way of business. Well the adage holds true for investing, as well – probably even more so. It seems easy enough to do, but when you see the value of your savings falling like a botched Martha Stewart soufflé, your first instinct may be to sell, sell sell! But acting out of emotion can often be the worst thing you could do when it comes to investing. Here are some tips to prevent sabotaging your financial well-being.
- Make sure you have a specific financial goal (or goals) with a specific time frame in mind. Sounds pretty basic, right? It may be, but the trick is to really give this some serious thought. Very rarely are you saving for just one thing at a time. Most of us are saving for retirement, future college costs, and near-term goals like buying a new car or house, a home remodeling project, or planning a big vacation. The way you invest for a short-term goal is very different from the strategies you would use to meet a goal that may be 30 years away, like retirement. Long-term goals require growth provided from stocks (equities), because you will need the money to outpace inflation. If you put your retirement savings into CDs, after thirty years, your investment would be worth less than what you put in because inflation would have reduced its purchasing power. Short-term goals require stability, because you plan on using the money soon. If the stock market has a set-back, you can loose a substantial amount of your investment in an eye-blink. Therefore, CDs, money market, or even short-term bonds would be a good choice for a shorter investment time frame. When I hear people say they want to make as much money as fast as they can – they need to know the reality is that the inverse holds true for that investment, as well. If an investment can move up in value rapidly, it is volatile and it could just as easily (and swiftly) move in the opposite direction.
- Diversify your investments. Yes, stocks are for growth and bonds, money markets and CDs are for income, but having a mix of investments can really protect your investments from times when the stock market may be volatile, or times when rates on CDs or money markets are anemic. Alternative investments, as a group might be risky, but when added to a portfolio (and combined in very specific percentages) can actually reduce a portfolio’s overall volatility.
- Start as early as you can, and invest regularly. The earlier you begin investing for your long-term goals, the better, because time is on your side. As your investment grows, you can take advantage of compounding, which is when you take whatever income or gains from an investment and buy more shares. Investing regularly is another good strategy, because it helps remove emotions from investing. By treating investing like a bill to pay every month, you stop thinking about how else you could spend the money. Over the years, the money adds up and one day you look at your balance, and you can’t believe how painless it was to actually save. Most mutual fund companies will even link payment to your bank so every month your bank account will automatically be debited and you won’t ever need to remember to write out and mail a check. There is also another big advantage to making regular fixed investments every month: it is called dollar-cost averaging. Because there may be some months when the price of a fund is lower than other times, you will buy more shares, and during the months when the price is higher you will buy fewer shares. The price, in effect, gets averaged out over time. It helps protect you from sinking all of your money into an investment on a day that may happen to be a high. Yes, this also means that you will not be buying on the absolute lowest day, either. But, since the market is impossible to time, this is the most logical (unemotional) way to invest, not to mention it puts an element of discipline into your commitment to invest.
- The markets can be fickle, but don’t you be. A well constructed plan needs to be followed out. If you shift your plan as the market moves, you will forever chase performance and be a reactive investor. Holding firm to your plan isn’t always easy, but deviating from it can prove fatal.
Remember, like most things, the planning is the hardest part. Once you’ve determined what your goals are, and how much time you have to reach these goals then you can begin selecting the right investments. Then, you can let your money work for you.