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| 5 Principles of Smart Investing |
By:
James Monroe |
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Smart investing isn't as hard as many financial pundits claim. In fact, it's easier, and most of what you hear on TV or read in financial magazines is more likely to cause you to lose money rather than gain. The main reason is that most talking heads have an agenda. They're either trying to sell you their product, sell a product to you where they get a cut, or sell you on a particular idea that they can benefit from. In this article we'll explain the five principles of smart investing, and why you really don't need to pay attention to the latest financial news.
Asset Allocation
Before you invest a dime you need to determine how you want to allocate your money, or into what assets. Are you comfortable with all of your money at risk? Probably not. You should have some percentage of your money in higher risk assets and some percentage in lower risk assets. The older you are, and the nearer you are to needing your investments, the less you want at risk. If you have too much of your money in risky investments the value could fall just as you need it most. If you won't need to touch your investments for 40 years on the other hand, you'll be ok with a larger proportion in higher risk, higher gain assets.
Diversification
Once you've decided what percentages of your money you want to put in which general classes of assets, you want to make sure you diversify in each one. For example, if you're putting money in stocks you don't want all of your money in a single stock. If that one stock tanks, all of your money is at risk. You should apply this principle to all of your asset classes. If you're investing in commodities you don't want all of your money in gold or silver for example, but in a diverse blend of commodities. This can be achieved by using index funds, as we'll mention below.
Index Funds
Index funds are set up to track an index. If you invest in an index fund for commodities, you'll be investing equally in all commodities that make up that fund. If you're investing in an index fund that matches the S-P 500, you'll own a piece of every stock in the S-P 500. The beauty of index funds is that they minimize your risk through diversification, and they eliminate management fees. Managed funds are not only subject to the abilities of the fund manager, but also the fees he or she will charge to manage the fund. Index funds will outperform managed funds in the vast majority of cases, and the money you'll save on fees will save you even more.
Rebalancing
After you've decided how you want to allocate your assets and picked diversified funds in each asset class, the only thing you'll be left to do is rebalance. If you've decided you want 20% of your money in US stocks, 20% in international stocks, 20% in bonds, 20% in CDs, and 20% in commodities, by the end of each year it's likely your balance will have changed due to gains and looses in each class. Once your portfolio gets out of whack, you'll want to "re-balance", spreading out gains to get back to your pre-planned distribution. This will have the natural affect of selling high and buying low, without attempts to time the market.
Not Timing the Market
One of the worst mistakes you can make is attempting to time the market. This means that you pull your money out when you think the market is going to go down and put it back in when you think it's going to go up. No one can predict the future, and timing the market is a losing game over time. You may see others get lucky, and you may even get lucky on occasion. But over the long run you'll make less money by attempting to time the market than you will through proper asset allocation, diversification, and rebalancing.About Author:James Monroe has been a financial advisor for more than 20 years. He writes for the informative website FinancialCalculator.org, which includes financial articles on mortgage refinancing and a free compound interest calculator. James is passionate about helping people invest their money to realize maximum gains with minimal cost and stress.
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