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The Best Investment Advice You'll Ever Get!Aug 15 '00 (Updated Apr 24 '01) Write an essay on this topic.The Bottom Line Start young, pay off your debts, buy stocks, diversify your holdings, buy and hold solid companies, minimize expenses including taxes. These are the keys to long-term investment success. When I was about twelve years old, my Uncle Joe, a lifelong investor sat me down and taught me about investment. He died a wealthy man, not because of any hot tips, fancy systems, or insider information, but simply by following a few straightforward principals. What he told me about investment can be summed up in one short sentence: Start young, pay off your debts, buy stocks, diversify your holdings, buy and hold solid companies, minimize expenses including taxes. Start Young The earlier you start investing, the more wealth you will build with the least overall effort. That's because of the power of compounding investment growth: for example, an investment that grows 10% per year will double in value in about 7 years. To get an idea of the power of starting early, look at this example: Let's say you start investing $132 per month in the stock market starting at age 25. Assuming a 10% annual return (roughly the average market performance over a century), you'll accumulate a cool $500,000 (that's right, half a million dollars) by age 60. If you wait just five years to start, you'd have to invest $221 per month to accumulate the same nest egg, and if you wait ten years, to age 35, you'd have to invest $377 per month. From a slightly different perspective, starting at age 25, you have to invest about $55,300 to end up with $500,000 at age 60. If you wait to age 30 to start, your investment will be $79,600, and if you wait to age 35, it will be $113,100. By starting young, you sacrifice the immediate gratification of spending your money on goodies. On the other hand, you guarantee that you will have far more discretionary income later on. Pay Off Your Debts Debts are exactly the opposite of investments. The interest you pay on a debt represents a negative return on your money. Pay off debts with the highest interest rate first. For most of us, this will be accumulated credit card debt with interest rates as high as 25%. Next, you'll probably want to pay off signature loans and car loans. Finally, consider paying off your mortgage, but realize that because of the combination of relatively low interest rate, deductibility of mortgage interest, and availability of investments with higher rates of return, it may be to your advantage to invest any extra money you have rather than using it to pay down your mortgage. Buy Stock The reason to buy stocks is this: successful companies grow. Over time, they increase their business, which tends to increase their revenues and profits. Since shares of stock are actually shares in ownership of a company, they tend to increase in value as the company's revenue and profit increase. That's why, over the long run, stocks have proven to be the best investment, better than bonds, commodities, gold, collectibles, or real estate, all of which are capable of price increases due to supply and demand, but none of which grow (an ounce of gold will never grow into two ounces, and your home will never grow by 1,000 square feet without an additional investment). Technically, growing a company almost always requires additional investments, but successful companies grow their profits much faster than they consume new investment dollars. Diversify Don't put all your eggs in one basket. If you buy individual stocks, buy at least ten different companies in at least five different industries. If you don't have a lot to invest, buy shares of a mutual fund that invests in a large basket of stocks. Balance your investment in stocks against some holdings of bonds, money market funds, real estate, etc. Diversification is especially important for people who hold stock or stock options in the company they work for. If your employer falls on hard times, you may be out of a job at the same time your stock holdings plummet in value. Thus, it's a good idea to diversify away from large holdings of your employers stock. Buy and Hold Solid Companies The statistics are in, and guess what: day traders don't do as well in the market as people who simply buy and hold the shares of good companies. Frequent selling, also known as churning, is a primary cause of poor investment performance. Part of the performance reduction comes from excessive brokerage commissions, higher tax rates on short term capital gains, the bid-ask spread imposed by market makers, and the psychological tendency of most people to make incorrect calls on market timing. The answer to all these problems is simple: identify good companies in good industries, buy their stocks only when they are reasonably priced, and hold them for the long term. On the contrary, don't jump into the latest investment fad. Minimize Expenses Investment expenses include brokerage commissions, mutual fund loads and annual expenses, margin interest, and taxes. You can minimize brokerage commissions by using a discount broker (regular or on-line), most of whom now charge under $20 for most stock purchases or sales. Beyond that, don't make a lot of trades; just buy and hold good companies. Buy a no load mutual fund unless you have a very good reason to buy a load fund (a load fund charges an up front fee for you to invest, typically around 5%). Among no load funds, choose one that meets your needs but has a low annual fee. For managed funds, shoot for an annual fee under 1%, and for index funds, shoot for a fee of under .25 % (one-fourth of one percent). Minimize Taxes Now, forget about brokerage commissions and mutual fund loads and fees for a minute. Taxes are your biggest investment expense, so anything you do to control taxes will pay off handsomely. Know the tax implications of anything you plan to invest in. In general, interest and dividends are taxed at the same rates as ordinary income, but municipal bond interest is generally not taxable. Short term capital gains are taxed at the same rates as ordinary income, but long term capital gains receive extremely favorable tax treatment. One very important point: it's generally not a good idea to buy mutual fund shares near the end of the year because that's when most mutual funds make their dividend distributions, which are taxable even though they generally do not increase the value of your holdings. Find out when the mutual fund you are interested in makes its distributions and consider waiting until afterwards. If you follow these principals, I believe you'll become wealthy, too.  |
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