Investing is critical to meeting your financial goals. You can improve the effectiveness of your investments by following a few simple planning rules. Here are some dos and don'ts of investment planning.
Here are five things to do if you want to develop a winning investment plan.
1. Develop a saving pattern
You can't invest unless you've saved. Develop a pattern of saving. U.S. Senator Elizabeth Warren popularized the 50-30-20 rule of budgeting. Those following that rule allocate 50 percent of their income to necessities, 30 percent to wants that aren't necessities, and 20 percent to savings.
Whether you follow the 50-30-20 percent rule, save a set percentage of each paycheck and aim to increase that percentage with each pay raise. Once you've saved enough for a rainy day, begin allocating your savings to investments.
2. Do research
Before investing, be sure you understand the risks and strengths of each option before choosing the best options for you. Depending on age, income, and goals, some investments will work better for you than others.
As you are conducting your research, also look at the tax implications of your investments. If you can make the investment with pretax income or if the interest is tax-free, your net return will be greater than might be initially apparent. Consult a financial adviser and tax accountant if you're unsure.
3. Do take advantage of employer-sponsored retirement plans
Investing for retirement should be a priority, even if you are just starting your career. Employer-sponsored retirement plans are one of the best ways to invest for retirement.
Many companies match your contributions. Matching contributions are essentially free money and can considerably increase your savings value. Be sure to contribute enough to receive all the "free money" you're entitled to.
For example, Joan works for the XYZ company which matches contributions to her retirement plan at a rate of 50 cents on a dollar up to 5 percent of her salary. Assume Joan makes $50,000 a year. If she sets aside only $1,000, the company will match that with $500. Her total contribution for the year is $1,500. While that's a good deal, she could still do better. To maximize the amount of free money she gets from her employer, she will contribute $5000 so that her employer contributes $2,500 (or 5 percent of her income.) At the end of the year, the total contribution is $7,500.
Before enrolling in your workplace retirement plan, consult with your human resources department to understand how the investment will impact your paycheck.
4. Do diversify
Diversification, or investing in various investments, is the key to successful investing because it protects from the market's fickleness. If you invest only in individual company stocks and the company has financial troubles, you'll take a significant hit. However, if you invest in mutual or index funds, the gains in other areas are more likely to negate your losses. Depending on your age and goals, you might diversify more between bonds and stocks to protect yourself from further volatility.
5. Do be patient
Unless you're willing to accept a lot of risks, investments tend to grow slowly. Don't expect them to increase in value overnight. Remember the story of the tortoise and the hare? Slow and steady wins the investment race, too.
Here are five things to avoid when planning your investments.
1. Don't try to time the market
To successfully time the market, you'll have to be perfect twice. You'll have to perfectly time when to buy a stock and then perfectly time when to sell it. Even the experts frequently get their timing wrong. Do your research, choose an investment, and stick with it long-term.
2. Don't let emotion govern your investment decisions
People who let their emotions govern their investment decisions generally earn less on their investments than those who can keep their emotions in check. Anxiety is a particularly challenging emotion.
Nobel prize-winning psychologist Daniel Kahneman says, "for most people, the fear of losing $100 is more intense than the hope of getting $150." Many people want to move to the sidelines as soon as the market downturns. However, in most cases, sitting tight is the best action during downturns.
3. Don't invest all your savings
Investments should be for the long-term. Keep some of your savings -- between three and six months of expenses -- in a rainy day account that is not in stocks or bonds. If you have an emergency car repair or are temporarily unable to work, you can access this fund without impacting your investments.
4. Don't wait
In your 20s, you may not be thinking about retirement. However, the earlier you start investing for retirement, the better off you'll be.
In a recent CNBC survey, 70 percent of retirees said they wish they'd started saving sooner. Creating earlier means you have to save less to achieve your goals because of the impact of compound interest. Compound interest means that interest builds on itself over time, so the longer the money is in your account, the more interest you earn.
You also may be able to save a more significant percentage of your income when you have relatively few family responsibilities than you'll be able to save when you have a mortgage and children.
5. Don't take advice from unqualified people
Taking advice on where to invest your money from someone that isn't qualified is a bit like playing the lottery. Instead, take your advice from a financial advisor or other qualified individuals who know your goals and have your best interests in mind.
Start saving early and invest for the long term. One of the best ways employees can invest is through group retirement plans.
People Corporation manages group retirement plans for organizations all across Canada. We are expert administrators and advisors and provide best-in-class service. If your company seeks a new plan administrator, call us. If your organization already provides a plan administered by People Corporation, contact your plan administrator for information on how you can start your retirement investment planning today.
In part three, we’ll show you how to assess your financial risk and create a plan to ensure you’re on the path to peace of mind.
Chris Walker is a Senior Consultant at People Corporation.