How to Build an Investment Strategy
Sure, there are some lucky people who do get rich quickly. People do win lotteries, hit the jackpot on the slot machine, and even pick the “right” stock at the “right” time, turning their investment into a potential fortune overnight.
But these fairy tales rarely come true. More often, we achieve our financial and personal goals when following the principle at the heart of Aesop’s Fable, The Tortoise and The Hare — that “slow and steady wins the race,” or more specifically that consistent, effective effort leads to success. In the investment world, this is more likely to be true.
Have a Consistent Plan
In the simplest terms, if you start early and consistently stick to an ongoing savings schedule where you set aside money on a regular basis, you should start to see your savings accumulate over the long term. However, just as in the Fable, (where the turtle used "smarts" — not just time — to his advantage), when investing, there are time-tested strategies that can help you reach your goal.
Stay Ahead of Inflation
For the same reason you wouldn't stash your cash under your mattress, when saving for the long term, most professionals wouldn't recommend “banking” all of your money. While it’s true that investments with a fixed rate of return, such as CDs (certificates of deposit), offer principal protection that others do not, they may not provide the growth you need when you factor in inflation.
Inflation refers to a general rise in prices of goods and services. Even low inflation reduces purchasing power over time, because as prices rise, a dollar buys less. For example, over the past 30 years (1983 – 2012), inflation has averaged 2.9 percent per year. This is a primary reason people invest in stocks, or equities. Over the long term, stocks historically have been an investment choice for some to outpace inflation.
Diversify
However, no one can control or predict the performance of the stock market, let alone a single equity. That’s why it’s important to diversify your portfolio across major asset classes to help you pursue optimal returns for the risk level that you’re willing to take. In addition, you’ll want to diversify within each asset class to take advantage of different styles and market sectors so strong performance in one area may be able to help offset downturns in another.
The goal is what professionals call “non-correlation.” That just means all of your investments are unlikely to move the same way at the same time. On any given day, some may be up and others may be down in value. In a well-diversified portfolio, you can realize the profit on the gains without losing too much on the losses. It all goes back to the age-old adage — don’t put all your eggs in one basket.
Dollar Cost Averaging
Another popular strategy is called “dollar cost averaging”. It works like this …
Say you decide to invest $10 every week in a mutual fund. If on the first week, the cost of a share in this hypothetical fund was $1, then your $10 would get you 10 shares. If the price of a share in the fund rose to $2 on the second week, your $10 would only get you 5 shares. But if the price of a share fell to 50 cents on the third week, $10 would get you 20 shares. (A stock’s price usually isn’t this volatile, but we’ve made it so for the purposes of demonstrating the principle of dollar cost averaging).
At the end of the three weeks, you’d have 35 shares after spending $30. So your average cost per share would be about 85 cents a share.
In short, more shares were purchased when the price is low, and fewer were bought when the price was high. It’s important to note the dollar cost averaging practice doesn’t eliminate risk. But investors use this method to make the cost for taking on the risk lower by lowering the average purchase price.
Make It Easy
Whenever possible you should consider setting up an automatic investment plan.
For example, if you invest in an employer-sponsored 401(k), you can set up automatic investments for each pay period. The percentage of your total pay (up to the maximum permitted) is taken out of your paycheck before any taxes and invested in the mutual funds or asset allocation strategy you choose. Your employer might even match a portion of your contribution. Not only do your savings accumulate, but the taxes on any investment gains you may realize are deferred until you retire and begin taking distributions.
Be Consistent and Smart
Consistency is the name of the game — as well as making a plan and sticking with it. Investors who change course a lot may be more likely to lose money.
Many investors put money regularly in a well-diversified portfolio, and reinvest all their gains and dividends along the way. But what’s financially appropriate can differ from individual to individual. Many people opt to consult with a financial professional to set an investment plan. But whether you’re saving for retirement, a new home or college education, slow and steady investing can help you win the race.
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Provided by Commonwealth Financial Group, courtesy of Massachusetts Mutual Life Insurance Company (MassMutual). ©2020 Massachusetts Mutual Life Insurance Company, Springfield, MA 01111-0001 CRN202112-257230