5 Investing Principles For Success

When it comes to investing, we like to make it harder than it really is. For whatever reason, we complicate things, thinking that we can somehow do things better or earn a higher return by doing something differently, tweaking something here or there. But studies show this is not the case. No one can outperform the stock market over the long-term on a consistent basis. Therefore, you are better left with the 5 basic investing principles that work. Here they are and if followed, you will have success investing in the stock market.

Understand The Power of Compounding

Too many of us don’t understand the power of compounding. Over time, our money grows upon itself and creates more and more wealth. I think the reason most investors, and most people in general, dismiss compounding is because they are only looking at it in the short-term.

When you begin investing, or saving for that matter, the amount of compounding that takes place is small. This is usually because of a short time period and a small balance. But as both of these grows, your money grows quicker as well.

For example, let’s say you have $10,000 and it grows at 8% per year. After one year your investment grew to $10,800. Nice, but nothing special. If we take this growth out to 20 years, your $10,000 grows into $46,000 and after 40 years, it is over $217,000!

With compounding, remember that the beginning is slow going and the growth speeds up through time. This is why it takes a lot longer to get to $1 million than from $1 million to $2 million.

Don’t Give In To Short-Term Fear

When you look at the performance of the stock market over the short-term, the volatility can be debilitating. But you have to remember why you are investing in the first place. For many investors, it is for retirement, which is a long time away. Even 10 years is considered a relatively short time frame for investing.

You have to keep your eye on the long-term and not give into short-term fear. Learn how the market works. The daily movements are large, but over time the trend is positive. Look at any historical chart for proof. You will see that the market rises over the long-term.

I like to use this analogy for those fearful of the stock market: picture a boat passing you in the water. Immediately behind the boat, the water is choppy. But if you follow the waves out farther and farther, the water clams down. This is the same as the stock market. Look well behind the boat where the water is calm and not right behind the boat where the water is choppy. The more you can focus on the long-term, the more success you will have.

Spread Your Risk To Grow Your Wealth

Investing in the stock market is risky. There is no return without some form of risk, regardless of what you are doing in life. As such, you need to take the steps to limit your risk as much as possible while still getting a return that meets your needs. You do this through investment diversification.

When you invest you money in various asset classes – large stocks, small stocks, international, and bonds – you reduce your risk and still allow for a healthy return. Note that I didn’t say you eliminated your risk because you cannot do that. You can only limit it.

You can learn more on the importance of diversifying here and how you can easily find out how diversified you are by creating an asset allocation spreadsheet. If you don’t like the manual task of doing it yourself, you can use a free service as well.

Invest On A Regular Basis

I’ve seen too many people try to “out-smart” the market by trying to time when to buy and sell. They failed and if you try this strategy you will fail too. No one knows what the market is going to do on a day-to-day basis. Just missing a few good days severely limits your returns. Don’t make this mistake.

You best bet is to invest on a regular basis. To many, this is known as dollar cost averaging. You do this when you contribute to your 401k plan and over time, it works wonders on growing your money.

This is because you invest when the market is up and down and so you take advantage of the price swings. Note though for this to work you have to stay invested. If you jump from investment to investments every so often, you are trying to time the market and in most cases aren’t earning the return you should be.

Take The Long Road Home

I am a firm believer in the strategy of buy and hold. You do your research, pick some good low cost mutual funds or exchange traded funds and keep adding to them over time. There is no point at trying to beat the market. As I mentioned at the start, no one has done this successfully on a long-term, consistent basis. This includes professional money managers as well.

Don’t fool yourself thinking you are smarter than the stock market. You are not. Accept this fact and control the things you can, like risk, costs, and focusing on the long-term. If you can do these things, you will grow a good sized investment portfolio that will ensure a happy retirement for yourself.