The 10 Golden Rules of Investing Every Investor Should Follow
Investing is one of the best ways to grow your wealth. But you have to approach it with some rules to get the most out of it while minimizing the risk. Whether you’re new to investing or have been at it for a while, following these golden rules of investing will help you stay on the right track and avoid the financial mistakes.
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1. Start Early and Be Consistent
One of the biggest rules of investing is to start as soon as possible. The earlier you start the more time your money has to grow through compound interest, meaning your initial investment earns returns and those returns earn returns, leading to exponential growth over time.
Let’s say you invest $5,000 at 25 in a retirement account that earns 7% interest. By the time you’re 65 your investment will have grown to over $74,000 due to compound interest. But if you wait until 35 to make that same amount investment, it will only grow to about $37,000 by the time you’re 65.
Consistency is just as important as starting early. It’s better to invest small amounts regularly than to wait until you have a large sum. Even a small monthly contribution to your investment portfolio can add up to big growth over the years.
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2. Diversify Your Portfolio
One of the most repeated investment advice is, “Don’t put all your eggs in one basket.” This is because diversification helps you avoid big losses. Diversification means spreading your investments across different asset classes like stocks, bonds, real estate and commodities.
Imagine you invest all your money in tech stocks because they’ve been doing great. Then a new regulation comes out that hurts tech companies and your portfolio collapses. But if you had also invested in bonds, real estate or international stocks, those other assets would have helped reducing risk.
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3. Invest for the Long Term
It’s easy to get caught up in the daily noise of the stock market but the reality is investing is a long game. Long term investing allows you to ride out the ups and downs and benefit from the overall upward trend in asset prices.
For example, when the 2008 stock market crashed, many people sold out in panic. But the market recovered over the next few years. If they had held on the stocks, they would have got their losses back and more.
4. Risk vs. Reward
In investing, the higher the reward, the higher the risk. You need to know your risk tolerance which is dependent on your financial goals, age and how comfortable you are with losing money. Generally younger investors can take on more risk because they have more time to recover from losses. Older investors nearing retirement may prefer safer and more stable investments.
Consider stocks and bonds. Stocks offer higher returns but are more volatile. Bonds offer more stable returns but lower returns. If you’re saving for retirement and have a long time horizon, you may be able to take on more risk with a stock heavy portfolio. But if you’re nearing retirement, you may shift to bonds to preserve your capital.
5. Don’t Invest Emotionally
Most investors are driven by two big emotions: fear and greed. When the market is going up, greed will push you to chase stocks that have already gone up a lot, at crazy prices. When the market is going down, fear will make you sell investments at a loss just to get out of the way of further declines.
But emotional reactions to short term market movements are a disaster for the long term. You need to be disciplined and stick to your strategy.
For instance, during the 2020 stock market crash caused by the COVID-19 pandemic, many investors freaked out and sold their stocks thinking they would lose more. But those who remained calm and stayed invested saw their portfolios grew as the market recovered.
6. Reinvest Your Dividends
Dividends are payments that companies make to shareholders for owning their stock. You can take these dividends as cash but a smarter strategy is to reinvest them into buying more shares of the same stock. This increases your ownership of that company.
Let’s say you own shares in a company that pays 3% dividend. If you reinvest that dividend instead of taking it as cash, you buy more shares with each payment, so your next dividend payout will be even bigger because you now own more stock. Over time this reinvestment can add up to big portfolio growth.
7. Stay Informed
Investing isn’t a set it and forget it. You need to stay up to date on market trends, economic conditions and company performance. This doesn’t mean you have to follow the stock market every day but you should make it a habit to check in on your investments regularly, read financial news and stay informed on any changes in the industries you’re invested in. You can follow reputable financial news sources like Bloomberg and CNBC.
8. Don’t Time the Market
Timing the market—trying to predict when prices will go up or down so you can buy low and sell high—is super hard. Instead of timing the market, focus on time in the market. Markets tend to go up over long periods of time, so the longer you’re in, the more likely you are to make money.
Let’s say you invested $1,000 in the S&P 500 in 1990 and held it for 30 years. The market had several crashes, recessions and booms over that time. But by 2020 your $1,000 would have grown to over $10,000.
9. Keep Costs Low
Every dollar you pay in fees and expenses is a dollar that doesn’t go into your portfolio. Over time high fees can eat into your returns. Be aware of the costs of your investments and look for ways to reduce them.
If you invest in a mutual fund with a 1.5% expense ratio you’re paying 1.5% of your investment every year in fees. Compare that to an index fund with a 0.05% expense ratio. Over 30 years the difference in fees could cost you thousands of dollars.
10. Have a Plan
Without a plan, you can make impulsive decisions. A plan should outline your financial objectives, risk tolerance, time frame and the investments you will make to achieve your goals.
For example, if you want to retire in 30 years, your plan might include a diversified portfolio of stocks and bonds, regular contributions to a retirement account and a strategy to rebalance your portfolio as you get closer to retirement.
Key Points
- Start Now: Get the power of compound interest working for you as soon as possible.
- Diversify: Spread your investments across multiple asset classes.
- Don’t get caught up in the short term: Don’t get emotional about the market.
- Know your risk: Align your investments to your risk tolerance and goals.
- Stay rational: Emotional decisions are bad for your investments.
By following these golden rules of investing, you’ll be on your way to achieving your financial goals.
Additional Resources
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