If you're thinking of investing in the stock market, you might be feeling a little intimidated, realizing that there's a lot you don't know. That's quite reasonable, but don't let it keep you from jumping in, as there are few better ways to build significant wealth over the long term than by investing in stocks.
Here are five rules to keep in mind as you prepare to build your portfolio.
1. Don't invest until you're ready
First, make sure you're ready to invest. That means, at a minimum, paying off any high-interest-rate debt you're carrying (such as that from credit cards) and establishing an emergency fund that can cover you in case your household suffers a job loss or faces a costly healthcare or automotive expense.
2. Have rational expectations
Next, you'll need to have rational expectations about the stock market. For example, don't expect to double your money every year or even every other year. The stock market's long-term average annual return is around 10%, and you might average less than that over your specific investing period. (You might average more, too!)
Expect to lose money now and then, if you're going to invest in stocks -- because some stocks turn out to be regrettable clunkers. It's also likely that the value of your investments will fall, possibly sharply, on occasion -- before regaining forward momentum. The stock of great companies doesn't rise in value in a straight line; it's a jagged line, with ups and downs.
Here are some more things to expect:
- Expect to make mistakes.
- Expect stock market crashes and corrections now and then.
- Expect to have to fight some emotions, such as greed and fear.
- Expect to be able to build a valuable nest egg for yourself if you stick with your plan.
3. Consider index funds
One of the best ways for most of us to invest in the stock market is through broad-market index funds. They're mutual funds (or exchange-traded funds (ETFs)) that hold roughly the same investments as the index they track, in roughly the same proportion, so that they can deliver roughly the same return -- less fees. So an S&P 500 index fund will perform nearly as well as the S&P 500 index of 500 of America's largest companies. Even Warren Buffett has recommended index funds for most people -- including his wife. Be sure to focus on low-fee funds, lest you end up paying more than you need to in fees.
4. Be a patient, long-term investor
You'll need to be patient if you want to build great wealth in stocks. When you buy shares of a stock, don't think about how much it might grow over the next few months. Instead, be thinking long-term. Seek companies that are likely to grow in value significantly -- over the coming decade or two. Or just stick with an index fund, adding money regularly and aiming for your wealth to build meaningfully over many years.
The table below shows what might be accomplished if you stick with it, riding out downturns and adding more money regularly:
Growing at 8% for
$5,000 invested annually
$10,000 invested annually
$15,000 invested annually
5. Keep learning
Finally, if you want to do as well as you can investing in stocks, keep learning. Obviously, you'll need to learn a lot at the beginning -- but the best investors tend to keep reading widely and deeply for the rest of their lives. They read annual reports, they read financial news, they read books about great businesses and business builders, and they read about great investors.
Starting to invest in the stock market can be one of the most important things you ever do, and the sooner you start, the better. So work on getting ready to invest, and then dive in!
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