To be clear, I am about to tell you to do as I say, and not as I do. I invest in individual stocks. Because of my business background, I like to read through financial reports, and pick companies that I feel are sound. I have made many mistakes though, and I have come to the conclusion that there is a simpler way to deal with the stock market for the small investor: index stocks.
If you have listened to the news of late, you will know that the stock market is a bit of a roller coaster. It may seem an unwise move to invest, but you may have also heard that traditionally, stocks produce an 8% return over time. This bodes well for the buy and hold investment strategy. Each time you are buying and selling stock, you will be charged, but if you hold onto a stock for five years or more, you have a better chance for a good return (profit) on your money. So my first bit of advice is to leave the money in the investment for some time.
If you look at graphs showing a stock’s price over the course of the year, you will see peaks and dips for most stocks. When will the stock hit its lowest price? When will it be at its highest price? If we knew, we could buy low and sell high, which is a sure fire way to make money. However, you and I do not have that kind of insight. Forget about these fluctuations, because it will make investing to difficult. Buy some stock each month without regards to price. Particularly when you can buy partial shares. By consistently increasing your holdings, you have a better chance to earn more during the times when the market is up. Additionally, you do not have to be so focused on what is happening in the market, since you are investing what you can afford and you are holding the stock.
The Standard and Poor’s index of five hundred stocks which represent the nation’s industries has outperformed all funds when everything is taken into consideration, like fees and the entire time period. The brilliant part of this index is that you can invest in a stock that tracks this collection of stocks. An S&P500 index stock will not have the charges that a mutual fund does, and you will get the best return for the least amount of effort.
Financial advisors want you to have a balance to your investment portfolio, so they recommend a mix of stocks, bonds, and cash. The percentages are 50% stocks, 25% bonds, and 25% cash. For the bonds, there is also an index stock that tracks a bond fund, which sets the standard like the S&P500 does for stocks. It is called the Lehman Aggregate Bond Fund, with the stock symbol AGG. These two investments tracking these indices is all you need. Out of each hundred dollars, invest $50 to the S&P500 index stock and $25 to the AGG, and then place $25 into savings. If you can, make that savings a money market savings account, since they have the better interest rate.
With these two investments, you can take the set it and forget approach, sort of. You really do not need anything else, but at least once a year, you will have to do a readjustment. Remember that the money you are saving is earning interest or it is increasing in value. This means that your 50%/25%/25% split will need to be re-established. Once a year, add up all of your savings. Divide this number by two to find out how much money you should have in the S&P500 index stock. By dividing your answer by another two, you find out how much you should have in your savings account and in the AGG. Adjust your savings amount to bring these in line next month.
One last thing before you go, reinvest your dividends. Certain companies pay out dividends (a share of the profit) to the stock holders. Any interest or dividend that you receive should go back into the stock. This increases your returns over time. This is a simple way to handle your brokerage account, which does not take much effort on your part.