In my endeavors to help people buy, sell and finance homes, I see many financial profiles ranging from families that struggle to others that have stability and others that have huge success. One differentiating factor is their commitment, focus and discipline to these three fundamental investment principles.
Please don't take this as formal financial advice as I am not formally trained in this area. Although I do have a MBA in finance from NYU, see a huge array of clients personal finances and do have some life experience that I can draw on, make sure you consult a financial advisor to find out what path is best for your situation.
Principle #1: Pay Yourself First: The Doubling Principle
To me, the Doubling Principle is a strong motivator to start investing sooner rather than later. Let's say your money doubles every 10 years. If you invest at 25 and retire at 65, you would have 4 "doublings."
For an example, let's use two as the base number. The first double would go to four, the second would be eight, the third would be 16 and the fourth would go to 32. So, $2,000 would be $32,000 in 40 years.
However, if you started to invest at 35, you would only have 3 doublings and the investment would grow to $16,000 vs. $32,000. WOW, the last doubling is HUGE and where you make the biggest money. This is the critical reason to start investing early and stay disciplined. If you waited and started to invest at 45 the $2,000 would only grow to $8,000, only 25% of the $32,000 for the early saver.
This is simply an example and there are no guarantees to investment returns, however, historical numbers show growth in a similar manner. By reviewing the items #2 and #3 below, you will have the other fundamental investment principles.
How Much to Invest
Typically, you should invest at least 10% of your gross wage per year. When you take this money out of your paycheck you will hardly notice. This is critical.
As you can see from the doubling example, it is important to start investing at a younger age. This is probably the most challenging time to start saving since you have the least amount of discretionary wage. Let the Doubling Principle motivate you because you'll appreciate it down the road and you'll be in the group of strong financial health.
Also, there are many opportunities with 401k's and IRA's to have tax advantages and possibly employer match. 10% of your gross wage to pay yourself first.
Principle #2: Dollar Cost Averaging
Dollar Cost Averaging simply means consistently investing over a period of time.
For example, given the choice to invest $12,000 with one purchase vs. buying $1,000 per month, the consistent buying over time is recommended. This works especially well when you are taking money each paycheck and investing.
When stocks are high, you buy less shares. When stocks are low you buy more shares. Over time, your investment becomes the average or the trend line of the market rather than trying to time buying at the bottom and selling at the top. You would need to get both the buy and the sell correct.
Top professionals are not able to consistently buy low and sell high, so Dollar Cost Averaging takes timing out of the equation. Simply buying every paycheck or every month will allow you to build a strong portfolio of stocks and bonds.
Principle #3: Diversified Portfolio
Diversification is the antidote to risk. Don't put all of your apples in one basket. If you only own one stock and the stock drops significantly then you stand to lose too much.
However, if you own many stocks and one drops it will only be part of a larger portfolio. There are mutual funds which are perfect for this because they own lots of stocks with a specific investment goal. Some are growth, some are international, etc. There are thousands of mutual funds, and I typically stick with the name brand well established funds.
Bottom line--diversification is key. Depending on your age and your investment goals will determine what the right portfolio is for you. There is a lot of information on the web for this and the concepts discussed in this article.
I truly believe if you follow these three fundamentals, your financial shape will be healthy especially when followed over a longer period of time. The time to start is right now.
Last disclaimer: I am not a financial advisor. It is recommended that you seek financial advice from someone or a company that spends their full time and their passion in this area. Personally, I have had great success with Fidelity. They have a huge knowledge base and are accessible. My passion is helping families buy, sell and finance homes.