You know about the ABCs. They represent the basics of any subject that you must master in order to move forward in that subject. Without the ABCs, you won’t succeed.
Did you know that when it comes to your investing, there are ABCs as well? In other words, if you don’t have a firm grasp on the following basics, you will fail.
Are you ready for them? Let’s dig in.
The “A” stands for asset allocation. This refers to how you split your money between the two major types of investments: stocks and bonds.
Why split your money between the two?
Two simple reasons: risk and return.
In the past, stocks have earned a higher return than bonds. Bonds, however, have been less risky than stocks.
Stocks and bonds also tend to move in opposite directions, so that when one rises in value, the other falls. So when you invest in both, you’ll have a nice balance between risk and reward, helping you sleep better at night.
Generally speaking, when you’re younger, you can take on more risk and invest more of your money in stocks. Then as you get older, it’s wise to lower your exposure to stocks and increase your exposure to bonds.
It’s important to allocate your funds across various types of investments, as described in the Core Four Portfolio.
The “B” stands for behavior. Specifically, I’m talking about your behavior. You see, while you’re in the process of growing your wealth, it doesn’t matter if the market goes up, or if it goes down.
Why? Because in either case, you should be investing steadily.
Unsuccessful investors buy after an investment has gone up in price, and sell the very moment that it drops.
Successful investors, on the other hand, control their behavior. They don’t panic when the market drops, and don’t get too excited when it rises.
They keep their emotions in check. They buy, and buy, and keep buying for years – until they’ve reached their goal and sell high.
The “C” stands for costs. This is important because the return on your investment is directly impacted by the cost of that investment. So the more you spend in unnecessary fees, the lower your return will be.
Let’s take a common investment for example: the S&P 500 Index Fund.
Many companies offer this fund. But not all funds are created equal. Here’s proof:
Don’t think this makes a big difference? Think again.
Let’s say you max out your Roth IRA (the current limit is $5,500) every year for the next 30 years. The S&P 500, which is made up of large-cap stocks, is expected to return 7.4% during this period.
Guess how much more money you’d have if you invested in Vanguard’s lower-cost fund.
If you invested in State Farm’s fund, you’d end up with $480,012. That’s pretty good.
But if you went with Vanguard’s fund, you’d end up with $540,337 – $60,325 more.
It’s the same exact fund. But a tiny difference in cost makes a huge difference in your returns.
What could you do with an extra $60,000?
What are some other basics of investing that are important to keep in mind? Leave a comment!