10 Rules for Successful Investing You Should Know
10 Rules for Successful Investing You Should Know
Whether you’re new to investing or have been at it for decades, following some tried and true rules can give you more confidence, reduce risk, and make you more successful. This post will review ten investing rules you should know and use to achieve your financial goals.
10 Rules for Successful Investing You Should Know
Use these rules to build more wealth through successful investing strategies and principles.
Know your financial big picture.
Before you fork over money for an investment, you must understand your financial situation and how investing should (or shouldn’t) fit into it. For instance, do you have any dangerous debts or need to fill insurance gaps that could devastate your finances?
You should have a healthy emergency savings account for short-term needs, like unexpected expenses, or something you plan to buy in a few years, like a car or home.
Your savings should never be invested. Keeping a cash reserve safe in an FDIC-insured, high-interest savings account is critical, so it’s always there for you. If you experience a hardship like losing your job or business income, having cash can keep you from getting into debt.
A good target for your emergency fund is three to six months’ worth of your living expenses (such as housing, food, utilities, healthcare, and debt payments). For instance, if you spend $5,000 monthly on living expenses, make a goal to keep at least $15,000 in savings.
2. Adopt long-term thinking.
Investing means choosing financial instruments, like mutual funds or exchange-traded funds, with the expectation of future growth, which means accepting some risk. The value of many types of investments can fluctuate wildly within short periods. That’s why
you should avoid investing money earmarked for short-term goals.
In general, you should only invest money if you plan to own the investment for at least five years, preferably a decade or more. So, selecting the best investments depends on your time horizon, the period you expect to own an investment. For most people, that will be until retirement or beyond.
Again, the money you expect to spend within the next few years should be saved not invested. But money you won’t need to touch for the long term is perfect for investing and building wealth.
3. Create a diversified investment portfolio.
Since no one can predict whether an investment’s value will rise or fall, buying individual securities (like stocks) isn’t wise for average investors. A better strategy is owning diversified investments, such as index, mutual, or exchange-traded funds (ETFs), which bundle investments like stocks, bonds, and other securities.
Diversification is a powerful strategy because it helps you reduce the risk of owning riskier investments, like stocks. You protect yourself by owning various investments that don’t all move in tandem when economic conditions change.
In general, diversifying your investments allows you to earn higher average returns while reducing risk. If some securities within a fund lose value, others can hold steady or increase value, minimizing potential losses.
Investment funds are highly diversified because they comprise hundreds or thousands of underlying securities while being convenient for investors to purchase.
4. Don’t try to beat financial markets.
Thousands of experienced, full-time market professionals and investment managers can’t earn returns that exceed the average market. In other words, it’s almost impossible to pick the right stocks or other investment vehicles that consistently give you higher-than-average returns.
The good news is that the historical average return of the stock market has been about 10% since the 1920s. So, if you have a long time horizon, consider investing primarily in stock funds. As I mentioned, stock prices within a fund can fluctuate significantly in the short term but will likely increase over the long term.
5. Minimize investment fees.
The more you pay in transaction and ongoing investment fees, the lower your returns will be. Sometimes, you don’t have control over fees, like what your workplace 401(k) charges to manage your account. However, you can choose investments inside a retirement or brokerage account that charge less, such as index and exchange-traded funds.
When comparing options, consider an investment fund’s expense ratio, expressed as a percent of your investment. For example, if you have $10,000 invested in an ETF with a 0.05% expense ratio, you’ll pay the fund $5 annually.
6. Understand investment taxes
Understanding how investments are taxed outside of tax-sheltered accounts is essential for being prepared to pay them. For more about taxes on investments, be sure to listen to last week’s podcast, episode 819, How Asset Location Cuts Taxes and Saves Money.
I recommend using tax-advantaged investment accounts, like workplace retirement plans, individual retirement accounts (IRAs), self-employed retirement accounts, and health savings accounts (HSAs), to reduce, defer, or eliminate taxes.
You can contribute to a retirement account If you have taxable compensation during the year, such as salaries, wages, tips, bonuses, commissions, or self-employment income.
The amount you can contribute to an IRA equals your taxable compensation up to $7,000 or $8,000 if you’re over 50 in 2024. What’s great is that minors can start saving for retirement when they get their first jobs, such as a part-time weekend gig or full-time summer work.
Other retirement accounts have higher annual limits. For 2024, you can contribute up to $23,000 or $30,500 if you’re over 50 to most employer-sponsored retirement plans. Depending on your self-employed income and age, you can contribute up to $76,500 to specific small business retirement plans.
7. Be familiar with retirement account rules
Retirement accounts can only be owned by an individual, even when you’re married. There’s no such thing as a jointly owned IRA or 401(k). Each retirement account owner must qualify to make contributions based on their income.
However, a minor’s parents can contribute on a child’s behalf up to the allowable limits–even if the funds come from a parent’s bank account. But you can’t deposit funds in someone else’s retirement account if they don’t qualify for it in the first place.
An often-overlooked retirement account rule is that If you’re married, file a joint tax return, and only one of you has compensation, the non-working spouse can max out a spousal IRA on your behalf. For example, if you’re a married, stay-at-home parent under age 50, you can contribute up to $7,000 in an IRA using your household income.
8. Use traditional retirement accounts for tax deductions
Traditional or regular accounts, such as a traditional IRA or 401(k), allow you to make pre-tax contributions. In other words, you don’t pay tax on the money you contribute in the current year. Instead, taxes on contributions and earnings are deferred until you make withdrawals in the future. You must begin taking required minimum distributions (RMDs) after age 72 or 73.
9. Use Roth retirement accounts for tax-free withdrawals
Roth accounts require you to pay tax upfront on contributions, so they’re not tax-deductible. However, you can withdraw Roth contributions and earnings entirely tax-free in retirement.
Like a traditional IRA, you can make Roth IRA contributions at any age as long as you have earned income. But unlike a traditional account, you never have required minimum distributions with a Roth. That means you can keep money in a Roth as long as you like or pass it to your heirs.
Another unique feature of a Roth IRA is that it excludes high earners. Your contributions are reduced or eliminated when your income exceeds annual thresholds. For 2024, single taxpayers can’t make Roth IRA contributions with modified adjusted gross income (MAGI) of $161,000 or higher. Joint filers are locked out with a household MAGI of $240,000 or above.
If you believe your income will be higher or the country’s tax rate will go up by the time you retire, it’s better to use a Roth to pay a lower tax rate on less income now. But if you believe your income or tax rate in retirement will be lower than today, it’s better to use a traditional retirement account.
Having some tax-free income from a Roth in retirement is a valuable benefit. But if you’re unsure whether a traditional or Roth account is better, you can split contributions, which I’ll say more about in a moment.
10. Use more than one tax-advantaged account.
Another overlooked rule is that you can contribute to multiple tax-advantaged accounts if you qualify. These might include a traditional IRA, Roth IRA, workplace plan, self-employed plan, FSA, HSA, HRA, or 529 college savings plan.
However, your total contributions can’t exceed allowable annual limits. For example, if you’re under 50, you could contribute $3,500 to a traditional IRA and $3,500 to a Roth IRA, or any proportion you like, in the same year.
You can even max out an IRA and a retirement account at work in the same year. However, when you (or a spouse) have a workplace account, your tax deduction for traditional IRA contributions may be reduced or eliminated, depending on your income.
This article originally appeared on Quickanddirtytips.com and was syndicated by MediaFeed.org
