Sep02

With returns averaging 10%, the stock market has proven to be the best place to park your money for the long term. These returns have beaten those of bonds, real estate, commodities, and all other asset classes. Of course, past performance does not guarantee future results, but what makes you think stocks wont continue going up?

Now, I dont recommend that you put 100% of your money in stocks, but what I do recommend is a diversified portfolio of stocks, bonds, commodities, and real estate.

Over the years, Ive learned quite a few lessons about the markets, investing, and planning for retirement. Here they are:

1. Take advantage of your 401k

This should go without saying if your company offers a 401k match, please take advantage of it. I would advise you to contribute as much as the company will match. My employer offers a 6% match, so I contribute 6%, for a total investment of 12% per paycheck. You dont pay any taxes on the money you contribute, or any taxes on the gains you receive, allowing for years and years of tax free compound.

2. Eliminate Debt

Before you even think about investing you need to payoff your debt, especially credit card debt. Whats the point in trying to build wealth when you just give it all back to the creditors in the form of interest payments? Payoff your debt, rebuild your credit. and then you can start to invest. Focus on paying off the highest interest rate debt first.

3. Invest in total market ETFs

Investing in total market ETFs such as the SPY. is arguably the easiest and safest way for a retail investor to get involved in the stock market. The SPY, which mirrors the S&P 500  is a smart choice for multiple reasons:

• Size The largest and most actively traded ETF.
• Performance It seeks to track the performance of the S&P 500, which has had annual returns of 10.88% .
• Dividend Currently its yielding 2.01%.
• Expense Very low expense ratio currently .10%. This easily beats the fees of similar mutual funds, and money managers which are generally around 1 or 2 percent.
• Diversification The SPY holds all of the S&P 500 index stocks and is heavily weighted towards stocks with large market capitalizations. It makes it a lot easier to sleep at night knowing youre diversified.

4. Never use margin

Margin is essentially a high interest rate loan from your broker, usually around 8% (this can vary). It can be very tempting to use margin when you feel the market, or a particular stock is cheap. From experience Im telling you dont do it!  If you cant pay for it in cash, dont buy the stock. If you think you are smarter than the market, youre wrong. Using margin is more likely to accelerate your losses.

5. Dont pay attention to after hours or pre-market quotes

Pre-market and after hours trading allows investors to act quickly to events that occur when the market is closed. Pre-market and after hours trading is going to have much lighter volume than normal market hours. For this reason, the price of stocks can easily be manipulated. You might often see stocks trading extremely high pre-market, only to close the day lower. I do not recommend trading in the extended hours. The only time I ever make a trade in the pre-market or after hours is when a stock shoots up, and I close out the position.

Tip: In pre-market, if the equity markets are set for a huge opening to the upside, be very careful. Professional traders usually fade (or short) a market that is set to open much higher.

6. Patience. Dont try to time the market.

A recent article from TIME magazine puts it best:

Three quarters of a century’s worth of reliable data has demonstrated that no one can predict, with both accuracy and consistency, which way stock prices are headed. Doesn’t matter whose results you study — hedge fund gurus, mutual fund managers, academic researchers, fortune tellers — they’re all just guessing, in one form or another, and sooner or later their theories or hunches are undone by reality.

Dont for a second think you are smarter than the market. Dollar cost averaging is probably the best approach for a long term investment strategy.

7. Leave your emotions out of it

Stocks go up and down. You should believe in every stock (or asset) that youre invested in. Panic selling is the worst thing you can do. I understand its difficult to hang in there sometimes, but it doesnt pay to panic and unload your positions. Go for a walk, take a break, do something to get your mind off it. From my experience, when it feels like you cant take anymore pain, thats probably the time you should be buying and not selling.

8. Diversify and invest in what you understand

If you chose to invest in individual companies rather than index funds, then please stay diversified and invest in companies you understand. There seems to be an illusion that you need to invest in complicated assets to be a winner, as if it gives you some sort of edge. Its just the opposite. Investing in companies you understand simply leads to more winning trades, and staying diversified will protect you from unexpected drops in those companies.

Never put all of your eggs in one basket.

Quick story. In 2003 everyone in my family wanted an Ipod for Christmas. Now, would you say that might have been a good indicator to buy Apple stock?  You bet! It was trading at only $9.00. Its currently trading at $380. It really is that easy just look for companies that make products you love. After that, you start to follow the stock, research the company, check the fundamentals, and finally if everything checks out invest.

9. Use stop and limit orders

This goes back to being patient. By using stop and limit orders youre automatically taking emotion out of your trades. Dont use market orders, they are for suckers. Get the prices you want.

Obviously there is no way to eliminate risk altogether, but the above tips can certainly help lower risk, and increase your investment returns.