5 Basic Rules for New Investors

Starting out on an investment journey can be pretty daunting. That is in spite of, or perhaps because of, the available amount of information and opinion. Once upon a time, the lack of information was the problem: The investment world was seen as a highly specialized environment where the price of entry was massive fees paid to a broker, where investors simply handed over their money and then checked their quarterly statements, hoping for the best. 

That isn’t the case now. There are literally hundreds of sites where new investors can get advice, instruction, up to date pricing, and opinions, but the sheer number of them and the variety of approaches makes it confusing and overwhelming for newcomers.

There are, however, a few basic, timeless rules that have been the keys to investing success for many decades. Taken together, they provide a starting point for new investors that will set you off on the right foot.

1: There’s No Time Like Now

The most common question most people have when starting out investing is “When should I buy?” They worry that maybe the market is too high and climbing too fast, or that stock prices are low and have been falling for a while. The fact that those two concerns are almost exact opposites shows why they should be ignored. You can always find a reason not to start investing, but none of them override the basic reason to start: stock prices go up over time, and the longer you are invested, the better your returns, so “now” is always the best time to start, particularly if you follow rule number 2.

2: Dollar Cost Average

This is a phrase you will often hear. It sounds kind of complicated, but the basic idea is very simple. It means investing in regular increments rather than all at once. Obviously, if you are starting out with a 401K or some similar contribution plan you will do this naturally, but it is also the best way to get started if you have a lump sum to invest.

Let’s say you have $10,000 from an inheritance or whatever. Investing $2,000 a month over the next five months means that you are in a good position whatever the market does over that time. Either stocks go up, in which case you bought some at the lowest level available to you, or they go down, in which case you will be buying some at a discount. Obviously, if the market powers higher immediately, averaging will result in some missed opportunity, but averaging is about managing your emotions, and the gains on your earlier buys will make you feel okay about holding back some of your funds.

3: Resist the Urge to “Play”

Investing is a long term project. Whether you are investing for your retirement, your kids’ college costs, or whatever, your investments will probably have a time horizon measured in decades, so responding to daily or short-term market moves makes no sense. Markets go up and down in the short term, but there is no rolling twenty year period in history when stocks have recorded a loss, and it is that, not scary stories in financial media, you should consider when making decisions.

Timing the market is difficult and usually not particularly productive, even if you get it right. Selling in anticipation of a 10% drop makes no sense if that drop doesn’t come for a few months, during which time stock indices climb by 15%. Even if your timing is perfect, you still face the issue of when to buy back in. What constitutes the bottom of a move down, or a bounce that turns out to be temporary? Is it 1%, which is easily within the range of normal daily volatility? Or do you wait for a 5% retracement, in which case you will have given back half of what you saved by selling. Just staying invested through the market’s ups and downs is far less stressful and almost always more successful, too.

4: Allocate Sensibly

Allocation in this sense is not just about the ratio of stocks to bonds in your account. That matters to some extent, but with the kind of volatility we have seen in bond pricing over the last decade or so, their old role as a stabilizing factor in your overall account value is questionable at best, so the stock/bond allocation is less important now than it once was. What does matter, though, is how much of your money you put in single stocks versus index or other funds.

Many people starting out investing believe that they should be buying individual stocks. Indeed, the most common question I am asked by such people is what ten or twenty stocks I would recommend they buy. My usual answer is that there are only three that should form the basis of your account: SPY, DIA, and QQQ. They are the ETFs that track the three major stock indices, the S&P 500, the Dow Jones Industrial Average, and the Nasdaq 100. One or a combination of those should make up around 80% of your stock portfolio because that ensures that you have exposure to a wide range of stocks, and also means that you will follow rule 5.

5: Keep Fees as Low as Possible

Lots of research has been done over the years that shows unequivocally that the biggest influence on investing success is how much of your return is taken from you in fees. Over decades, the compounding effect of paying a 1.5 or 2% fee on an account balance is massive. This report from The Pew Charitable Trust, for example, shows that the difference between fees of 1.5% versus 0.3% on $200 per month invested over 40 with an average 6% annual return would be over $80,000, or around 30% of the total.

Fortunately, the days when such fees were an inevitable cost of investing are gone. Most platforms now offer free trades in ETFs, and all three of the funds mentioned above have expense ratios below 0.1%.

Final Word

If you start investing today, then these five rules are a good starting point. As time goes on, you will inevitably become a little more sophisticated as an investor and may want to add things like overseas exposure, or adjust your account to favor some sectors or styles depending on your opinion of economic conditions etc. 

That is fine, as long as you never lose sight of the basics: now is the best time, averaging in works in your favor, ride out volatility, diversify and allocate sensibly, and keep an eye on fees. If you follow those rules you are not guaranteed to succeed, but you will have a much higher chance of doing so than if you ignore them. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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