Failure to Plan equals Planning to Fail
This ought to be just about the simplest idea you could imagine. If you’re going to invest in the stockmarket you need to know why you’re doing it and have a plan to make sure you achieve your objectives. Yet most people don’t do this. In fact most private stockmarket investors rarely have much of a plan beyond “buy stocks in companies and get rich”. The buying the stocks bit works but usually the getting rich side is a problem. It’s a bit like relying on winning the lottery for your retirement.
Actually it’s exactly like relying on winning the lottery for your retirement.
Just the Facts, Please
A few facts and figures:
1. The longer you invest in the stockmarket the less your risk of making a loss. Over one year you have about a one in three chance of losing money. Over ten years it’s about zero. However you have to wait up to twenty five years to be sure of making a decent return.
2. Investing all your money at the same time means you risk buying at the top of the market and waiting a very long time to get your money back. On the other hand you might get lucky and buy at the bottom, but luck is something we don’t want to rely on. The same is true in reverse when you want to get your money out.
3. Based on the second half of the twentieth century you could reasonably expect to make between 8% and 12% per year return, on average, over a long enough period.
4. If you spend the dividends (interest) paid by your stocks instead of reinvesting you’ll massively damage your returns, possibly by up to 80%.
5. The more you spread your money around the stockmarket the less your risk. This is called diversification. However, there are limits to this because …
6. … the more you buy and sell stocks the greater the fees and the less money is left for you.
A Twenty Five Year Plan
So any plan that involves investing for less than twenty five years is highly risky. Getting in a position where you need to get the money out of your investments at short-notice is not recommended. Having an expectation that you can make money every year is unrealistic. Believing you can make more than 10% a year is foolish. Spending the dividends from your investments will mean it’ll take a lot longer to build a decent pot of money.
Twenty five years is a long time. It’s simply not possible to predict everything that will happen to you over that period. However, we do know that the earlier you invest the bigger your pot of money at the end – early money has longer to grow, so start investing as soon as you can. It’s not something to put off.
In addition stuff happens. Cars break. Jobs are lost. People get ill. As you don’t want to have to pull your money out of stocks at short notice you need other cash in hand, in case of calamity. Making sure that you have your short-term fund available is crucial as you grow your investments. Cash, though, is not an investment – sticking your money in an interest bearing account won’t make you wealthy.
Diversification and Index Trackers
Diversifying your holdings is important. If you hold stock in one company and it goes bust you lose all your money. If you hold stock in ten companies and one goes bust then you lose a tenth. And so on. However, there’s a limit on how many stocks you need to hold to get enough diversification and there are lots of complications about how you should combine different sorts of company stocks. Generally it’s easier to buy an index tracker which effectively holds the stocks of all companies in an index.
There’s another reason for buying index trackers – they have low costs and these mean there’s more money left over for you. Buying and selling individual stocks (also known as “churning”) is also an expensive business due to the fees that this attracts. It may be OK if you really know what you’re doing but most investors lose money against the market (which means that they may make money but they’ll make less than they would have done by doing nothing with a tracker).
For many people this strategy of getting rich slowly isn’t good enough. They want to make their money quickly, retire early and live high on the hog for the rest of their life. Which is possible. If you’re very, very lucky.
We don’t do luck here, so we don’t do that.
The Basic Rules
So:
• Have a cash reserve so you don’t have to sell stocks in a hurry.
• Invest regularly in the stockmarket for a long time – 25 years at least.
• Start investing as soon as you can – early money grows the most.
• Re-invest all dividends from your stocks.
• Don’t expect to make much more than 10% a year on average.
• Don’t churn your stocks because this costs money.
• Unless you really know what you’re doing use an index tracker.
In addition the closer you get to retirement the more you need to think about reducing your exposure to the stockmarket. Stock prices can collapse suddenly and take years to recover, you don’t want that happening just as you’re about to go on a permanent vacation.
Don’t Panic
Finally, don’t worry about short term panics. They will happen and the world will seem to be about to end. If it really ends you won’t care about your stocks. Otherwise, the stockmarket is your best chance of a long and comfortable retirement.
Next up: we’ll explain why stocks and shares are really the only way of safely investing for the future even though the stockmarket itself is an incredibly risky place to do business.
See: Stepping Stones #2: Understanding Why Investing in Shares is Necessary.
This ought to be just about the simplest idea you could imagine. If you’re going to invest in the stockmarket you need to know why you’re doing it and have a plan to make sure you achieve your objectives. Yet most people don’t do this. In fact most private stockmarket investors rarely have much of a plan beyond “buy stocks in companies and get rich”. The buying the stocks bit works but usually the getting rich side is a problem. It’s a bit like relying on winning the lottery for your retirement.
Actually it’s exactly like relying on winning the lottery for your retirement.
Just the Facts, Please
A few facts and figures:
1. The longer you invest in the stockmarket the less your risk of making a loss. Over one year you have about a one in three chance of losing money. Over ten years it’s about zero. However you have to wait up to twenty five years to be sure of making a decent return.
2. Investing all your money at the same time means you risk buying at the top of the market and waiting a very long time to get your money back. On the other hand you might get lucky and buy at the bottom, but luck is something we don’t want to rely on. The same is true in reverse when you want to get your money out.
3. Based on the second half of the twentieth century you could reasonably expect to make between 8% and 12% per year return, on average, over a long enough period.
4. If you spend the dividends (interest) paid by your stocks instead of reinvesting you’ll massively damage your returns, possibly by up to 80%.
5. The more you spread your money around the stockmarket the less your risk. This is called diversification. However, there are limits to this because …
6. … the more you buy and sell stocks the greater the fees and the less money is left for you.
A Twenty Five Year Plan
So any plan that involves investing for less than twenty five years is highly risky. Getting in a position where you need to get the money out of your investments at short-notice is not recommended. Having an expectation that you can make money every year is unrealistic. Believing you can make more than 10% a year is foolish. Spending the dividends from your investments will mean it’ll take a lot longer to build a decent pot of money.
Twenty five years is a long time. It’s simply not possible to predict everything that will happen to you over that period. However, we do know that the earlier you invest the bigger your pot of money at the end – early money has longer to grow, so start investing as soon as you can. It’s not something to put off.
In addition stuff happens. Cars break. Jobs are lost. People get ill. As you don’t want to have to pull your money out of stocks at short notice you need other cash in hand, in case of calamity. Making sure that you have your short-term fund available is crucial as you grow your investments. Cash, though, is not an investment – sticking your money in an interest bearing account won’t make you wealthy.
Diversification and Index Trackers
Diversifying your holdings is important. If you hold stock in one company and it goes bust you lose all your money. If you hold stock in ten companies and one goes bust then you lose a tenth. And so on. However, there’s a limit on how many stocks you need to hold to get enough diversification and there are lots of complications about how you should combine different sorts of company stocks. Generally it’s easier to buy an index tracker which effectively holds the stocks of all companies in an index.
There’s another reason for buying index trackers – they have low costs and these mean there’s more money left over for you. Buying and selling individual stocks (also known as “churning”) is also an expensive business due to the fees that this attracts. It may be OK if you really know what you’re doing but most investors lose money against the market (which means that they may make money but they’ll make less than they would have done by doing nothing with a tracker).
For many people this strategy of getting rich slowly isn’t good enough. They want to make their money quickly, retire early and live high on the hog for the rest of their life. Which is possible. If you’re very, very lucky.
We don’t do luck here, so we don’t do that.
The Basic Rules
So:
• Have a cash reserve so you don’t have to sell stocks in a hurry.
• Invest regularly in the stockmarket for a long time – 25 years at least.
• Start investing as soon as you can – early money grows the most.
• Re-invest all dividends from your stocks.
• Don’t expect to make much more than 10% a year on average.
• Don’t churn your stocks because this costs money.
• Unless you really know what you’re doing use an index tracker.
In addition the closer you get to retirement the more you need to think about reducing your exposure to the stockmarket. Stock prices can collapse suddenly and take years to recover, you don’t want that happening just as you’re about to go on a permanent vacation.
Don’t Panic
Finally, don’t worry about short term panics. They will happen and the world will seem to be about to end. If it really ends you won’t care about your stocks. Otherwise, the stockmarket is your best chance of a long and comfortable retirement.
Next up: we’ll explain why stocks and shares are really the only way of safely investing for the future even though the stockmarket itself is an incredibly risky place to do business.
See: Stepping Stones #2: Understanding Why Investing in Shares is Necessary.
