Five Steps to Smart Investing

1. Take stock of your situation. Before focusing on your investments, make sure your emergency fund is in place, your debt is under control, and you're protected against financial loss with appropriate insurance. Then brush up on investing basics and don't invest in anything you don't understand, leaving complex and high-risk investments, such as options, futures, penny stocks, and limited partnerships to the pros. Remember, too, that part of smart investing is investing in yourself, so enhance your ability to make money by keeping your job skills and knowledge up-to-date.



2. Think long term and invest for growth. Keep cash you'll need in the near future where its principal value won't fluctuate, such as in a savings or money market account. However, money you're saving for long term needs, such as retirement, has time to ride out the inevitable ups and downs of the market and should be invested where it can grow enough to meet your goals, such as in stocks or stock mutual funds. If you tuck away your long term money in low-return savings accounts, you avoid market risk, but you leave yourself open to inflation risk. For example, assuming even a modest 3.5% average annual inflation rate, today's $1000 will buy just $709 worth of goods and services in ten years.



3. Divide your money among different types of investments. How you allocate your assets is one of most important investment decisions you have to make. Diversify your investments in two ways: among different types including stocks, bonds, and cash, and among different categories within these types. Diversifying helps reduce risk and can improve returns because different types of investments tend to move in different cycles. When deciding how to divvy up your money, view all your investments that are earmarked for a specific purpose as part of one whole pie. For example, if you and your spouse each have an employer-sponsored retirement plan, think of these two accounts as one retirement portfolio. Then divide your whole portfolio into portions, investing each in a different type of asset. Once you set up your appropriate asset allocation, rebalance your portfolio at least once a year to bring it back to your original target.



4. Make investing routine. Take advantage of easy ways to invest, such as mutual fund automatic investment plans, employer retirement plans, and automatic reinvestment plans. In addition to helping you invest regularly, these plans allow you to practice what's called dollar-cost averaging. By investing set dollar amounts regularly, you make the best of market fluctuations because your money buys fewer shares when prices are up, and more when they're down. While this strategy doesn't guarantee profits or protect against losses, over the long run it lowers your average investment cost and increases the potential for higher returns.
   
   Investing regularly also helps you steer clear of the pitfalls of market timing. Trying to guess when to sell before a market downturn and when to get back in before an upswing, or when to shift money among different investments, is a game even the pros seldom win.



5. Monitor your progress. Review your investment goals and strategies at least once a year to make sure your plan still meets your needs and make any necessary adjustments. If significant events occur in your life, such as a job change or new baby, do an immediate review. Also, review how your investments are performing by comparing their returns to their appropriate benchmarks. For example, measure how your U.S. large-company stock mutual fund is performing compared to the Standard & Poor's 500 Index.

Return to FAIRWINDS University Article Index