Do you dream you’re the toast of Wall Street only to wake up to a more pedestrian reality? Contrary to popular belief investments are not only a way the elite consolidate their riches but a wealth-building tool the average worker can employ quite easily. An encyclopedic knowledge of finance isn’t even necessary if you possess common sense and patience. Investors typically lose in the market in only one of three ways, those being panic, inattention to transaction costs, and failing to account for unknowns. Fortunately you can mitigate all of those concerns with the proven system of dollar cost averaging.
Dollar cost averaging: This time-tested idea is a great way to put money into the financial markets a little at a time, thereby reducing risk. An investor employing this method deposits money into his or her brokerage account on a regular schedule, usually payday, and sticks with a small number of solid financial vehicles. By wading into an investment slowly the buyer does not lose a great deal if there is a sharp drop early on; capital has been been preserved to purchase shares next week at the lower price. Set a recurring balance transfer and an amount, sticking with your plan no matter what. As you’ll see when you read below an insurance policy will already be in place for when the going gets really tough.
Panic: Buying in gradually at fixed intervals forgoes the impulse to time the market. Egoism destroys your average investor. The big boys are counting on you to panic and sell right before the market turns around. They wait and wait until you break and then scoop up your shares at a reduced price. This isn’t meant to scare you but to drive home the importance of having a strategy to combat your fears. Bear in mind that if you lose 50% of your money it takes a 200% gain to get back to your original amount!
Stops: It is absolutely mandatory that you find a broker who has the option to put electronic stops on your orders. Stops monitor the price of your stock and execute an order (usually a sale) when a fixed price is met. They protect your capital as the order will trigger before you lose your entire investment, with rare exceptions. Companies go bankrupt every day and I hope you’ve protected yourself when the unthinkable happens and you’re holding their common stock.
With stops you determine how much you’re willing to lose, or more optimistically how much you would like to make, and set the conditions for the sale accordingly. They should never be changed. If your stops are already set you have no need to think of, check on, or worry about your investments. Dollar cost averaging with stops is a system designed to minimize the time spent watching a boring stock ticker, not to mention prevent you from arbitrarily deciding you want to sell after a bad week.
What to buy: You should consider mutual funds or exchange traded funds. The proper batch of these will grant you diversification and preserve your capital from a downturn. You want exposure to large, mid, and small cap stocks as they complement one another. A mix of commodities, technology, mining, and international stocks will help prepare you for whatever financial challenges might come. You couldn’t achieve this diversification with individual stock picks because the combined purchase fees would erase any potential gains. A smart investor is a passive investor; watch the melee of other traders from the sidelines while reducing your own transaction costs. Sometimes the best trade is the one you don’t make. Remember that when you buy and sell actively you’re effectively competing against those giant brokerage houses with their sophisticated machinery. Stay away from them cowboy!
The fun without the pain: Part of what attracts people to stocks is the adrenaline boost when dealing with large amounts of money. You need to distance yourself from the rush of being a trader as much as you can. To this end you might get your rocks off by playing a stock game online with virtual money. Marketwatch has a great tool for this. All of your impulsive decisions can be made where they can’t possible hurt you while your calculated, researched choices are made with real money. I hope that these tips will help catapult you to success in your new hobby. Call Charles Schwab, a fine discount broker, and tell them you’re ready to start your financial journey. Stay defensive and stay safe!