Welcome to List of Five week. All this week, I’m going to be dispensing my usual advice and commentary in the form of lists of five (hence the name of the week).
To start off this week, we’re going to take a closer look at five of the many financial clichés that are out in the ether. Unless The Amateur Financier is one of the first things you are reading on the subject of investing and personal finance, chances are you’ve read or heard these gems of wisdom already, perhaps many times. But what do they really mean?
1) Pay Yourself First – Probably the most famous advice about retirement saving of them all, pay yourself first relates to how you should save for retirement. Basically, you should take 10% of your gross salary (or more; depending on your age and other data, some experts would recommend 15%, 20% or more) and invest it for your retirement. In essence, you treat your retirement funding like a bill from your future self, and make sure you pay that bill before any others.
Why is this such popular advice? Well, retirement is possibly the only big goal for which you can’t get a loan. Unlike college loans or a mortgage, there aren’t retirement funding loans you can get for your golden years. (Which should make sense; you would need to have such loans last until you shuffle this mortal coil, at which point it would be hard for them to collect what you owe.) Furthermore, treating your retirement savings as a regular expense makes it harder to blow off saving, and the decreased money available for spending will help you to live within your means. It’s the investment advice equivalent of a hat trick.
2) Buy Low, Sell High – Ah, the classic advice on how to get rich; buy (whatever) at a low price, then sell (that same whatever) at a much higher price. But the question is, how do you know when the (whatever), such a stock, is at a low price and when it’s at a high price? You could get all kinds of answers, depending on who you ask; value investors would tell you to compare the current price to the fundamental value of the company, technical traders would rely on signals from the stock price, and other investors would share yet more advice.
One good, and fairly simple way, to buy low and sell high is to create an asset allocation that meets your needs and rebalance it when it gets too far from your desired allocation. If you want a portfolio that is half US stocks and half foreign stocks, you could buy two mutual funds that track those respective groups of stocks. Then, if some time went by and you found that the US allocation was only about 40% of your holdings, you could put all your new investment money into buying more shares of the US-invested mutual fund (buying low) or sell off some shares of the foreign invested mutual fund (selling high) to get your portfolio back in alignment.
3) Diversify, Diversify, Diversify – Not quite as famous as ‘Location, Location, Location’, encouragement to diversify your holdings is widely considered a good way to hedge your investments. If you diversify between asset classes, that is, holding a mix of stock, bonds, and other investments, you can help to cushion the blow if one or more of your holdings takes a hit. (Even in the nasty investment climate of the past several months, there were still some investments that increased in value, like Treasury bonds.)
Diversifying within each asset class can also benefit your returns. If you buy only one stock, you have the risk that the company could go bankrupt and you’ll lose all your money. Hold ten stocks of companies that are in a variety of fields, and the chance that you will lose all your money goes down substantially. Hold all the roughly 8,000 publicly traded US companies, as in a US Total Market mutual fund, and nothing short of a total financial Armegeddon will destroy your investment completely.
4) A Fool and His Money Are Soon Parted – Not a cliché that deals with investing directly, but a broader money comment. There are people who rely on the lack of financial and investing knowledge to take advantage of those who need advice and help with their money. If you don’t know what you are investing in, don’t invest. There are plenty of easy to understand investments out there; there’s no need to jump into something that doesn’t make sense to you.
5) It’s Not Where You Start, It’s Where You End Up That Matters – To end on a more positive note, keep in mind that saving and investing is not a single event, it’s more of a journey. Even if you’ve never invested a penny up to this point, starting now can have a huge impact on your future finances. It’s never too late to start investing in your future.