While each investor might have their own approach to investing, there are some best practices that make sense most – especially for those new to the investing game.
New (and experienced) investors must keep in mind that Investing comes with risk. New investors, in particular, are likely to make some mistakes as they’re learning the ropes, but it’s also possible to avoid many of those mistakes by following a few simple rules for investing.
What to Know About Rules of Investing
There’s no simple road map to investing success, but there are some basic guidelines that have stood the test of time. These are principles that hold true for most people in most situations, and following them can help you keep your emotions out of your investment decisions.
It’s up to individual investors to decide which rules make the most sense for them, based on their own investment goals, risk tolerance, and time horizon. Using these rules, even those who might be hesitant to invest can find a way to get started.
Here are 11 investing rules to consider:
1. Build an Emergency Fund First
Having a separate account with money you’ve set aside for emergencies before you start investing means that you won’t have to tap into your investments when an unexpected expense like a leaky roof or job loss happens. Depending on whom you ask, most specialists recommend a savings cushion of four to six months’ worth of expenses in an emergency fund.
As the pandemic has proven, unexpected things can happen at any time and without much notice. That’s why it’s important to have an emergency fund before you start building out the rest of your portfolio.
Once an emergency fund has been established, it doesn’t all have to sit in cash. With inflation at more than 4% and rising, money in a basic cash account is simply losing value over time.
However, you may want to consider keeping your emergency fund in a safe, liquid account, such as a high-yield savings account or a money market account. Money market accounts are similar to high-yield savings accounts in that they yield higher interest and have a set limit on the amount of withdrawals account holders can make each month.
2. Take Advantage of Free Money
If you have access to a workplace retirement account and your employer provides a match, contribute at least enough to get your full employer match. That’s a risk-free return that you can’t beat anywhere else in the market, and it’s part of your compensation that you should not leave on the table.
3. The Sooner You Can Start the Better
In general, the longer your investments remain in the market, they have the propensity to do better over time. That’s because long-term investments benefit from compounding, which means that your earnings generate additional earnings over time, and then those earnings generate earnings, exponentially increasing your returns.
The longer that your investments have to compound, the more they can earn. Even if you can’t invest much at first, small amounts can grow substantially over time.
4. Build a Diversified Portfolio
By creating a diversified portfolio with a variety of types of investments, across a range of asset classes, you may be able to reduce some of your investment risk. This strategy aims to ensure that when some investments go down, others go up, creating a balance that limits losses.
5. Make It Automatic
One of the easiest ways to build up an investment account is by automatically contributing a certain amount to the account at regular intervals over time. If you have a 401(k) or other workplace retirement account you likely already do this via paycheck deferrals. However, most brokerages allow you to set up automatic, repeating deposits in other types of accounts as well.
Investing in this way also allows you to take advantage of dollar-cost averaging, which reduces your exposure to volatility. By spreading out buy orders rather than buying investments all at once, you will purchase more of an asset when its price has gone down, and less when the price has gone up.
6. Stick with Your Plan
When markets go down, it can feel like the world is ending. New investors might find themselves pondering questions like How can investments lose so much value so quickly? Will they ever go back up? What should I do?
During the crash of early 2020, for example, $3.4 trillion in wealth disappeared from the S&P 500 index alone in a single week. And that’s not counting all of the other markets around the world. But over the next two years, markets hit repeated record highs.
The takeaway? Investments fluctuate over time and prices will change. If you have a long time horizon, you may not need to be overly concerned with how your portfolio is performing day to day.
7. Watch Out for Fees
No matter whether you’re taking an active, passive, or automatic approach to investing, you’re going to have to pay some fees to managers or brokers. For example, if you buy mutual or exchange-traded funds, you will typically pay an annual fee based on that fund’s expense ratio.
Fees can be one of the biggest drags on investment returns over time, so it’s important to look carefully at the fees that you’re paying and to occasionally shop around to see if it’s possible to get similar investments for lower fees.
8. Maximize Tax Advantaged Accounts
Like fees, the taxes that you pay on investment gains can significantly eat away at your profits. That’s why tax-advantaged accounts, those types of investment vehicles that allow you to defer taxes, or eliminate them entirely, are so valuable to investors.
The tax-advantaged accounts that you can use will depend on your workplace benefits, your income, and state regulations, but they might include:
• Workplace retirement accounts such as 401(k), 403(b), etc.
• Health Savings Accounts (HSAs)
• Individual Retirement Accounts (IRAs), including Roth IRAs, SEP IRAs, SIMPLE IRAs, etc.
• 529 Accounts (college savings accounts)
9. Consider Your Time Horizon
One of the most important factors in determining your investment strategy is your time horizon, or the amount of time you have to invest before you need to start taking money out of your account.
So, for example, a Gen Z investor saving for retirement that’s decades away would typically have a much more risky portfolio than a Baby Boomer who has just a few years left of work. That’s because the younger investor has plenty of time to let their investments recover any potential losses before they need to tap into them.
10. Rebalance Regularly
Once you’ve nailed down your asset allocation, or how you’ll proportion out your portfolio to various types of investments, you’ll want to make sure your portfolio doesn’t stray too far from that target. If one asset class, such as equities, outperforms others that you hold, it could end up accounting for a larger portion of your portfolio over time.
To correct that, you’ll want to rebalance once or twice a year to get back to the asset allocation that works best for you. If rebalancing seems like too much work for you, you might consider a target-date fund or an automated account, which will rebalance on your behalf.
11. Understand Your Personal Risk Tolerance
While all of the above rules are important, it’s also critical to know your own personality and your ability to handle the volatility inherent in the market. If a steep drop in your portfolio is going to cause you extreme anxiety – or cause you to make knee-jerk investing decisions – then you might want to tilt your portfolio more conservatively.
Ideally, you’ll land on an asset allocation that takes into account both your risk tolerance and the amount of risk that you need (and are able) to take in order to meet your investment goals.
If, on the other hand, you get a thrill out of market ups and downs (or have other assets that make it easier for you to stomach short-term losses), you might consider taking a more aggressive approach to investing.
The rules outlined above are guidelines that can help both beginner and experienced investors build a portfolio that helps them meet their financial goals. While not all investors will follow all of these rules, understanding them provides a solid foundation for creating the strategy that works best for you.
A great way to get started putting that strategy to use is by opening an account on the SoFi Invest® brokerage platform. You can use the platform to build and manage your own portfolio of stocks and exchange-traded funds, or you can opt for automated investing and allow SoFi to create and manage the portfolio on your behalf.
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