If you've been a fan of The Motley Fool for any length of time, you know we love investing. It's the best way to grow your wealth over the long term, but it's not magic. You still have to take the right steps to set yourself up for success. If you don't make the following essential moves, you're not going to be very happy with your results.
1. Actually investing
Investing is intimidating for many, because there is a risk of loss. But what most people don't realize is there's also a risk to not investing. There's no savings account on earth that can match the stock market's average annual return. And since the inflation rate often exceeds a typical savings account's annual percentage yield, you could actually lose money by being too conservative with your finances and locking your money up in one of these low-yield accounts.
If you take the right steps, including diversifying your money and choosing the right asset allocation, you can grow your wealth through investing while reducing your risk of catastrophic loss. That's not to say you'll never lose money — ups and downs are a natural part of investing. But as long as you plan to hold your investments for at least five years, the stock market's daily fluctuations shouldn't bother you too much.
It's worth noting that just putting your money into an investment account doesn't mean you're actually investing it. You need to use your funds to purchase stocks, bonds, mutual funds, exchange-traded funds (ETFs), or other securities. Otherwise, you just have a pile of cash sitting in an investment account where it's not going to earn any interest.
2. Taking care of high-interest debt first
High-interest credit card or payday-loan debt often costs more than people typically earn on their investments. Some credit cards have annual percentage rates (APRs) exceeding 30%, while payday loans can have APRs of 100% or greater. That means your payday loan debt could double in a single year.
The stock market, on the other hand, has only earned a 30% return in five of the last 30 years, and sometimes, it has experienced losses. On average, you can expect about a 10% annual return, and that's if you invest all of your money in stocks. If you have some bonds mixed in there, you're probably looking at a slightly lower return. Unless you're lucky enough to invest in a company whose stock skyrockets overnight, you're probably not going to earn enough on your investments in a year to make up for what you're losing in interest on credit card or payday-loan debt.
If you have any high-interest debt, you should make paying it off a priority before you begin investing your money. A balance transfer card or a personal loan are good places to begin. Trim your budget as much as you can, and put your extra cash toward paying off your debt every month. Once your debt is cleared, you can turn your focus back to investing.
3. Choosing good investments
The definition of a good investment varies depending on your risk tolerance, timeline, and financial goals. But there are a few things all good investment portfolios have in common.
First, they're diversified. Putting all of your money in one basket is dangerous, because it means you need that one investment to do well or you could lose everything. When you spread your money among different securities, one poorly performing stock doesn't hurt you quite as much. Ideally, you should have at least 15 to 20 stocks in your portfolio.
Great investment portfolios also keep fees to a minimum. There's no way to avoid them completely, but there are plenty of solid investments that charge less than 1% of your assets per year. Stick to these whenever possible. Paying 1% of your assets might not sound like much, but on a $1 million portfolio, it means giving up $10,000 per year — that is sure to put a damper on your nest egg's growth.
Index funds are a great way to diversify your portfolio while keeping your costs low. These are bundles of stocks that mimic a market index like the S&P 500. They tend to generate returns that are close to that of the index itself, and because the securities in the fund don't change very often, there's less work for fund managers. They're able to pass that savings along to you in the form of lower fees.
Even if you follow all of the steps above, you may not have the smoothest ride to wealth. Investing isn't predictable, but if you start slow and commit yourself to learning more, you should begin to see progress over time.
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