By Tom Cleveland, investor analyst for the ForexTraders website
Hindsight can be wonderful, especially in the world of investing, but how many of us “older” types would have benefited from our parents taking us aside and teaching us the value of long-term investing? One rarely encounters the topic during our organized educational process, but once in out twenties and employed, the time is ripe to take the simple rule of compounding and use it to full advantage. The best time to start investing is during this period, as demonstrated by this common chart used to illustrate this basic principle:
The obvious conclusion is that if you invest $5,000 a year, in this case into a tax-sheltered Individual Retirement Account (“IRA”), then your returns over time will increase dramatically, compared to starting later in life. Here are a few tips to help get you going in the right direction:
1) Time Is on Your Side: In the example above, there was an assumed annual rate-of-return of 7% over the period. Investing is all about assuming a level of risk that will return gains over time in line with your financial objectives. Rates of return will never be constant, but over long periods of time, they do tend to average this assumed amount if you invest wisely in stocks. Yes, there will be good and bad years, but you have time to weather bad markets, learn valuable lessons, and get better at investing over the long run;
2) Three Factors for Success: In every medium of investing, whether stocks, commodities or currencies, the keys to success are the same – knowledge, experience, and emotional control. Time also works for you here. Read as much as you can, accept your amateur status, and enroll in a free investing seminar in your local area. As you build your knowledge base, experiment with paper-trading or any electronic tool that your broker will provide. In the process, you will notice the psychological aspects of putting real money on the line. You can deal with fear and greed by always having a disciplined plan of attack that you fine tune and moderate over time;
3) What Type of Investor Are You?: Investors tend to fall into two categories. One group researches their options and then invests for the long-term with a “buy-and-hold” strategy. The other type prefers a more active management investing style, attempting to achieve his objectives with short-term opportunities as they present themselves. Investors are usually a blend of these two extreme types, but your choice will depend on your personal tolerance level for risk. All investment mediums have different risk profiles. You must understand the risk and how to manage it in order to reap an appropriate reward;
4) Diversification is a Risk Management Tool: In line with never putting all of your eggs in one basket, diversification of your asset holdings is the best way to achieve an acceptable risk profile for your portfolio. Exchange-Trade Funds (“ETFs”) were designed to achieve this goal. Fees are low, and shares can be traded with high liquidity for the more popular vehicles. You can easily craft a well-balanced portfolio by owning shares in a variety of sector ETFs;
5) Investing is Hard Work: You must invest the time to get good at this financial discipline. No shortcuts allowed, unless you find a good mentor or investment advisor to guide your progress. In any event, your results will not depend on blind luck or intuitive gambling instincts, but on your personal effort to follow your plan and improve over time.
Time is on your side, so enjoy the adventure!