If you look just at the number of people who directly buy stocks in individual companies and profit from those investments, most people lose money in the stock market. The investment growth that most people experience comes from their investing money — usually through a 401(k) or similar plan — in mutual funds that are managed by professional investors. Of course, all mutual funds have good years and bad years, and so the conventional wisdom is that if you’re going to invest in the stock market you want to keep your money there for at least 10 years.
But ten years is a very long time for most people. In ten years you can get married, have children, buy a house, become disabled, and lose your spouse to death or divorce. It is not easy to leave stock market investments alone and more than half of all people who invest in the stock market take out at least some of their money too soon according to the time tables set by conventional wisdom.
On the other hand you really cannot predict how much money you will make each year for the next ten years so planning for ten years’ worth of investments is more of a mental exercise than an actual strategic option. It’s fine to play with the numbers and make some plans based on what you would like to do, but you should re-evaluate your financial needs every 6-12 months and adjust your savings and investments.
Now that we have covered all that, here is a conservative approach to investing in the stock market that works pretty well. Understand that this is not a high-growth investment strategy. It is simply a process by which you manage the flow of your money into the stock market.
Step 1: Only Make Deposits into a Money Market Fund
Depending on your investment plan these accounts may be called “Liquid Asset Funds”, “short term funds”, and other names that are confusing. Generally speaking these funds maintain a stable share value of about 1 dollar. These funds usually grow slightly due to the interest that they earn from investing in easily disposed investments like certificates of deposit, savings accounts, short-term bonds, etc.
Whether you are investing directly in the stock market or through a retirement plan it is better to make your deposits into a liquid fund. You want to maintain a minimum balance in that fund of several hundred to several thousand dollars. If you can only invest $1-200 a month you may not want to move any money out of this first investment fund for at least 6 months. Sure, you’ll miss some opportunities but investing in the stock market works best when you take a long-term view. When you start your 10 years seldom matters very much because there will be ups and downs during the next decade.
By habitually investing only in the liquid value fund associated with your investment accounts you’ll be able to reverse course quickly and easily whenever you need to change your investment deposits. The liquid fund creates a buffer between you and your true wealth-generating investments.
You will occasionally want to purchase several hundred to several thousand dollars’ worth of shares in a mutual fund or stock. By maintaining a sufficient balance in your liquid fund you won’t have to sell shares out of other mutual funds or stocks before you are ready to do so.
Step 2: Invest in an Index Fund Early On
Before you start getting adventurous with your investments, teach yourself patience by investing in a major index fund first. You’ll be able to use the value of your index fund investments as a baseline for tracking growth and contractions in your other investments. Index funds are named for the popular indexes you hear about on financial news, such as the Dow-Jones Industrial Average or the Standard and Poor 500.
Index funds are managed so as to match the growth and contraction of these major indexes (which is why they are called “index funds”). You won’t see an index fund vary much from the reported index valuation. The fund owner will buy and sell stocks as required to maintain the right balance of stocks.
So while you may not see a great deal of growth right away in your index fund, this is usually considered a safe investment and it gives you an opportunity to learn how mutual funds work. Through the mutual fund you will own pieces of all the major companies that make up the index that the fund tracks.
You can make future investments in the index funds or just watch your initial investments grow over time.
Step 3: Study Other Types of Funds to Learn How they Earn Money
Mutual fund managers may invest your money in companies that pay dividends, in a mix of stocks and bonds, or just in bonds or just in stocks. They may grow the value in the funds by buying and selling assets in the continual up-and-down cycle, by reinvesting dividends and interest, or both.
Some mutual funds will experience rapid growth over several years; but every mutual fund will eventually experience a slow in growth or even a decline in value. You may want to buy into mutual funds when they are rising and sell out of them when they begin to fall, but be careful. Panic selling can cost you money.
Knowing how the stock market works gives you some insight into interpreting the occasional spikes and dips and you can make purchase/sell decisions on the basis of what is called a “trading range” — the normal range of highs and lows that affect a stock, bond, or mutual fund.
But since no one can predict when the stock market will take off or crash you cannot rely on past performance to predict future results. Sooner or later you’ll make a buy or sell decision at the wrong time. That is why you want to be patient as much as possible and not worry about short-term fluctuations.
Step 4: Set Goals for Moving Your Money Around
You can leave your investments alone or you can make decisions about when you will sell out of them. You should think about how high you’re willing to go and how low you are willing to drop. You want to take profit every now and then and you want to cut your losses short.
Investing on the basis of hope is a very risky strategy. It is better to look at the solid growth and try to determine where the cycle will top out; or to look at the continual decline in an asset’s value and try to determine how low it may go before it turns around.
You never actually make or lose money until you sell out of an asset. Any changes in valuation between your purchase and sale of asset shares is really meaningless.
The chances of your striking it rich in the stock market are very slim, but you should be able to grow your investments over time provided you don’t pull out of the market in a rush or make a lot of bad purchase/sell decisions. The fewer purchase/sell decisions you make the less likely you’ll make many bad decisions.