Investors starting today have access to more information and technology than ever before. However, with these benefits comes a problem – how can new investors cut through the noise and learn how to invest effectively?
A smart plan will put the investor in the best possible position to generate returns while managing risk. In this post, we’ll learn why smart investing is simple investing. Use these four immutable rules to succeed in any market.
Let’s start with a riddle. What advantage does a first-time investor in their mid-twenties have over an industry expert of 60 with decades of experience?
The answer is deceptively simple: youth. With a greater time horizon comes more earning power. Moreover, a young investor is better suited to withstand the inevitable ups and downs of the market. Markets fail investors. With a long-term approach, these bumps smooth out. An older investor nearing retirement cannot weather these changes because they’ll soon need to withdraw cash and if the market crashes they’re in trouble.
Consider someone who is twenty and opens their first account. This person makes a €5,000 investment. Left untouched, and returning 8% annually, the value reaches to €180,000 by the time they turn 65. Now, imagine this same person waits. At 40 they make the same investment with the same return. Upon reaching 65, the total grows to less than €40,000. The penalty for waiting is more than €140,000. Bottom line: start now.
Many consider diversification to be the most critical rule when investing. The practice of spreading your investments across various asset classes is important for two reasons. First, diversification mitigates risk. A significant interest rate hike can immediately decimate the wealth of an investor holding a portfolio consisting only of bonds. Holding 100% stocks can see savings cut in half as they did during the global financial crisis when the Dow Jones Industrial Average fell more than 50%.
Second, diversification allows an investor to enjoy the outperformance of different sectors. As we’ve discussed in earlier posts, investors who want to grow their savings while outpacing inflation will need to expand beyond the conventional approach of just stocks and bonds. Marketplace lending is becoming an increasingly popular asset class for investors. Marketplace lenders in the U.S. alone generated more than $10 billion in originations in 2014. The following year this total more than doubled to almost $23 billion. Diversification allows investors to get in on the ground floor of this kind of explosive growth.
Remember this phrase: Costs kill. Keep investing fees low. At first, a fee of 1% seems inconsequential. Do the math. One analysis determined that such a fee could eradicate more than half a million in wealth. How is this possible? It’s easier than you think.
A 25-year-old has €25,000 in a retirement account. Over the next 40 years, they add €10,000 annually while earning 7%. When it comes time to withdraw this 1% fee reduces the total value by €590,000. This 1% fee is a reasonable assumption given that the industry average expense ratio is 1.01%. Moreover, funds commanding higher fees regularly perform worse than their low-fee counterparts. “Equity funds with the lowest expense ratios had a 62% success rate over the five years ended Dec. 31, 2015 — three times greater than the success rates of funds with the highest expense ratio,” explains a writer reviewing research from Morningstar. Keep costs low. You’ll keep more of your money while earning a higher return.
The greatest enemy of an investor is one’s self. Remain unemotional. Market downturns create panic leading people to sell rather than play the long game. The way to win is to stay invested and outlast market fluctuations. At Bondora we help people do just this with our automated Portfolio Manager tool. With automation, you are invested and continue to invest without distraction.
Discipline also keeps an investor grounded within their risk tolerance. That is, discipline is sometimes the practice of getting too speculative with your investments or consolidating too heavily in one asset.