Bank savings accounts currently offer paltry rates of interest. If you put leave all your money in banks it should be safe but will not grow much. The stock market offers much more interesting returns but because of the element of risk many people avoid it. Worse still they might enter the market at the top and then sell out later at the bottom. Here are some simple rules to help you navigate the market and build a large stock portfolio over a long period.
1. Diversify. Spread your risks by investing in a number of stocks in different markets and in mutual funds, bonds and other instruments. A good rule is that no one stock or other investment should be more than 10% of your total portfolio. Invest in different geographic areas such as US, Europe, Asia and emerging markets. Diversify into property funds, commodity funds and hedge funds. This should give you protection against a collapse in any one particular sector.
2. Do your research. Take advice from various sources. Invest in some companies whose products and strategies you like. There are a multitude of comparison sites and other resources on the internet to help you to analyse and understand investments. Past performance is no guarantee of future performance but I would generally prefer to choose a mutual fund or unit trust that had been a strong performer over the last two years and which offers low management fees.
3. Run the stars and sell the dogs. Monitor your investments and compare their performances against the market index. If some of your holdings do well then the temptation is to cash in and take a profit. It seems natural but if you are in this game for the long term then you want investments that grow over the long term so when you find winners cherish and retain them. On the other hand you should ditch the dogs that significantly under perform the market. The temptation is to hold onto them in the hope of a rebound or worse still to increase your holding at the lower price. This is generally a poor strategy and it is safer to take a small early loss rather than a large one later on. Do not cling onto stocks for emotional reasons. Sell the dogs and run with the stars.
4. Reinvest dividends. A surprisingly large part of the overall growth in most portfolios comes from reinvested dividends rather than in appreciation of the stock prices. A yield of 3% may appear small but over a period it makes a big difference. Choose some investments with a solid history of dividends and use them as the ballast in your ship.
5. Be contrarian. This advice is much easier to give than to observe. When the stock market is low buy stocks. When the stock market is high sell your worst performing stocks and buy other investments such as property or bonds.
6. Take the long view. You are in this for the long term so do not make frequent trades – the commission will eat into your funds. Do not follow fads and fashions. Diversify in a sensible way. Do not panic when markets occasionally crash – these are buying opportunities for the brave.
Finally be prepared to sell when you eventually need the money. You invested it to build financial security for you and your family so it is better to use it when needed rather than to scrimp along in order to become the richest man in the cemetery.
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