Investing has always felt a bit more like an art to me than a science. However, over the years, I have taken a more measured, scientific approach to it, cultivating a set of interdependent strategies that have helped me steadily grow my wealth at an average of 12% annually regardless of market conditions. Granted, different people have different goals and timelines, so this is not a one-size-fits-all strategy. But for those looking at a 20+ year horizon with overall wealth creation as the primary objective, these strategies should help novice investors mitigate risk while taking advantage of the power of compounding.
Diversify, Diversify, Diversify
Investors often hear this mantra repeated endlessly, but doubtful they really consider all that it encompasses. Many people think portfolio diversification simply means “stocks and bonds,” but there are other asset classes as well, including real estate, commodities (gold, silver, frozen orange juice), futures and good old-fashioned cash, which often exhibit characteristics wholly distinct from stock and bond markets. Moreover, this is just one type of diversification. Other types include by sector (healthcare, energy, consumer products, etc.), market capitalization (small cap, mid cap, large cap), and domestic versus international. The more diversified your portfolio is in all ways, the more easily you can weather unexpected drops or volatile price fluctuations.
Dollar Cost Average
Many investors try to time the market — that is, buying an instrument at a low valuation and then selling it high. The problem is that no one (and I mean no one) knows what the market is going to do. How do you know if you’re buying low when the price can drop even further the next day (or vice versa)? Making this feat even more challenging is the fact you have to time the market twice: when you get in and when you get out. Instead, employ dollar cost averaging, which entails dividing up the total amount you want to invest and gradually pushing it into the market over time. Try to use set intervals like the beginning of every month or the end of every quarter. The key to this strategy is staying the course no matter what the market is doing. Up or down, it doesn’t matter, especially with your long time horizon.
If you’re under 50 years old and have an adjusted gross income of less than $140,000 a year (or $206,000 if you’re married and filing jointly), you can contribute a maximum of $6,000 a year to a Roth IRA account. That amount goes up to $7,000 if you’re 50 or older. Once your money is in a Roth, you can use it to buy and trade the same instruments you would in a normal brokerage account. But a Roth allows your earnings to grow tax free as an incentive to save for retirement. What’s the hitch? You can’t withdrawal any monies from it until your 59½ without a substantial penalty (barring a few notable exceptions). In addition, if you have an employer willing to match your contributions in a traditional IRA, where earnings are tax deferred, take advantage of that up to the highest match amount they allow.
Avoid Unfamiliar Foreign Exchanges
Unless you’re intimately familiar with an exchange, the country it’s based in, and the investments listed on it, just avoid it altogether. There are plenty of great investment opportunities on well-known domestic exchanges, so there’s really no reason as an everyday joe to move capital into obscure and exotic exchanges like the Deutsche Börse or Shenzhen or Riga. The NYSE and Nasdaq offer plenty of great stocks in both the growth and value sectors, and many of the large companies listed will offer international exposure anyway. This way, you’re not risking your assets in a marketplace that may be affected by geopolitical and other factors you don’t understand. The best bet is to simply stick with stocks listed on trusted indexes like the S&P or Dow.
Buy Dividend-Paying Stocks
Owning stocks that pay dividends means not having to constantly monitor them for unrealized gains and losses as you wait for the right time to cash out. Because otherwise, even if the stock is up, you haven’t made any money unless you sell it. However, through dividends, you continue to make real money whether the stock price is up or down; you can then reinvest that dividend back into the stock at whatever price it’s currently trading for (dollar cost averaging!) and watch as the power of compounding takes affect over subsequent years. In general, stocks that pay dividends are able to do so because the company has reached a level of success selling its product or service that allows it to distribute excess profits to its shareholders rather than reinvesting them back into operations and such.
Buy Stocks with a Lengthy History of Dividends
It’s not only advisable to look at whether the stock pays a dividend (any company could start doing that next week!), but how long it’s been paying that dividend and whether the company has been raising it each year. Companies listed in the S&P 500 that have a track record of paying and increasing their dividends for at least 25 years are called “dividend aristocrats.” Their stocks tend to reflect solid leadership, a consistency of vision, strong underlying financials, and a significant market capitalization that allows the organization to weather storms that might arise. Not all your stocks will be aristocrats, but dividend growth of at least eight to 10 years straight allows for peace of mind that your investment will likely continue to bring in reliable income needed to grow wealth regardless of market downturns.