I am going to keep this one short and to the point. Many people think investing is all about picking the right stocks that are going to 100x in the next 10 years — and while that would be great to be able to do, very very very few people can consistently do that.
So… if it’s not all about that, what is the key to investing?
1. Invest Early and Often
I don’t think it is possible to talk too much about compound interest and the importance of maximizing your total time in the market. It is drastically misunderstood and undervalued. The best thing you can do for your future is to start investing now, continue to invest every month and dollar cost average into the market, and stick with it through tough times.
2. Invest In A Strategy You Believe In
Everyone is going to try and tell you exactly how they invest and why you should too. While their strategy may work for them, it may not for you. Let’s say your best friend invested half his net worth in Dogecoin and has made a ton of money in the past year. That’s great, but it doesn’t mean you should do that. First of all, who knows if that will ever go up in price again, but more importantly Dogecoin is his belief, not yours. If you invest in it because it has done well for him and not because you believe in it, you are going to have some really hard times. Think about 3 months down the line when Dogecoin is down 30%, if you don’t truly believe in it, you are going to think this is the end of its run and sell out of fear. You never want to do this.
This scenario is exactly why you want to invest in what you believe. You need to be able to stick with your strategy through the ups and downs of the market for it to work in the long run.
3. Figure Out Your Goal, Invest Based On Your Risk Tolerance, and Don’t Just Chase Returns
This one goes hand in hand with #2. Before you invest, you need to understand what the goal with this money is. If the goal is to buy a house in 5 years you would not invest the same as if the goal was retirement. Those two scenarios have completely different time horizons, and the longer the time horizon, the more risk you can take. In the short term, the market is volatile, so you could easily be down when you need that money for a down payment — but for the long term, the market tends to go up (based on history, but no guarantee).
Many times after people hear the argument above, they say “Well I need to make some money in the market to be able to afford the down payment.” This is a position you don’t want to be in. Chasing short term investment growth through aggressive investing can be a dangerous game to play. It may feel okay to do because of how the markets have been the last 5 years, but this isn’t how the market always is.
Lastly, you need to figure out what your risk tolerance is. Your risk tolerance tells you how well you can handle downturns of the market. Once you know this, you can determine the right asset allocation (how much you should invest in stocks vs bonds, large companies vs small companies, etc.) for your individual risk. This helps ensure you have a portfolio that you can stick with when the market takes a dive, which is going to happen plenty of times during your investment journey. Here are some key facts for you (Nick Maggiulli):
- There is 10% market decline every other year
- There is a 30% decline every 4-5 years
- There is a 50% decline once a generation
So safe to say you will experience volatility and need to be prepared for it.
4. Use Tax-Advantaged Accounts
Taking advantage of tax-advantaged accounts like ROTH IRA’s, 401(k)’s HSA’s, 529’s, can make a massive impact on the future value of your accounts. If you don’t have specific short term goals to be planning for that require taxable dollars, you should try to maximize these accounts first.
How much of a difference can these tax-advantaged accunts make? Let’s compare the difference between using a ROTH IRA and a taxable account. If you had $100,000 in a ROTH IRA, 30 years from now using an 8% return you would have just over $1 million dollars. However, if you used the same numbers but had the money in a taxable account the story would be a little different. Let’s say you still held onto those investments the whole time and never sold, you would still have around $1 million dollars. The difference is that once you sell, you will either have to pay 15% or 20% in capital gains tax meaning you would end up with at least $100,000 less in the long run. This is a huge difference.
I do want to note that taxable accounts offer more flexibility since you can use these dollars whenever you want. With a ROTH you can only use the contributions you made whenever without a penalty, not the growth.
5. Set It and Forget It, Don’t Try and Time The Market
Too many people think they are an investment guru and can understand when the market is at the top and or bottom, but in all reality they can’t. You spend way too much time trying to decide when to sell or when to buy back in and oftentimes end up missing some of the best days in the market. This chart here will show you how important it is to be in the market on the best days.
Look at how impactful missing the 5 best days in the market is! You drop almost 30% from trying to time the market and missing the 5 best days. I hope you can use this and understand why you should stop trying to time the market. Simply set up a monthly investing plan and forget about it. Let it keep accumulating for you.