Investing is key to financial success. If you don't invest to build a nest egg and accomplish financial goals, you'll have nothing to show for a lifetime of labor.
Of course, you don't want to invest your money just anywhere -- you need to be smart about what you invest in so you can grow your wealth and become financially free.
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To make sure you invest the right way, here are five investing rules you should know by heart.
1. Invest as early as possible and as much as you can
Compound interest works magic on your money, turning small and steady investments into a big nest egg that buys financial freedom. The sooner you start investing in assets that produce a reasonable rate of return -- and the more you invest in those assets -- the harder your money will work for you.
If you start investing at 25, you must invest just $380 monthly over 40 years at 7% to become a millionaire by 65. A total investment of $182,400 leaves you with seven figures. But, if you wait a decade until 35, you need to invest $820 monthly -- $295,200 -- to achieve the same goal. That's $112,800 more.
Of course, investing as much as possible makes a difference, too. Increasing a 401(k) investment by just $1,000 annually starting at age 25 would give you an extra $200,000 by 65 at a 7% return -- for just $40,000 additional dollars invested.
2. Take calculated risks
Rule No. 1 specifically mentions investing -- not just saving. While saving means putting aside money you don't spend, investing means buying assets that have the potential to provide a reasonable rate of return.
If you save a ton of money but keep cash under your mattress, that money loses value over time thanks to inflation. If you want your nest egg to grow, you need to invest.
This doesn't mean sinking your savings into lottery tickets, even if you have the potential to turn a $1 investment into millions. You need to take calculated risks.
Everyone has a different risk tolerance, but the general rule of thumb is to invest in riskier assets -- such as stocks -- when you're young and have time to recover from downturns. As you get older, move some of your invested money to safer investments with a lower potential rate of return, but less chance of losing it all.
3. Don't invest money you'll need right away
While investing is essential, you don't want to invest every spare dollar. You need some liquid assets, or accessible cash.
Some investments require you to tie up money for months or years to earn returns, and withdrawing early can trigger penalties. For other assets, such as stocks, you want to be able to leave money invested to weather downturns.
If you're going to need cash right away -- say, to pay next month's mortgage or next year's college tuition -- you don't want to risk not being able to access money when you need it. A good rule of thumb is to keep cash in a savings account if you'll need it within the next two years, rather than investing it.
But, if you have a longer timeline, look into getting your money invested so it can work harder for you.
4. Don't invest in anything you don't understand
Taking calculated risks requires you to actually understand both the potential reward and the likelihood of loss.
That means you need to know how the investment will make you money, whether the asset has a history of providing promised returns, and how losses could happen.
Unfortunately, too many investors jump on bandwagons without knowing why. It's this phenomenon that led to a joke currency, Dogecoin, briefly becoming worth around $2 billion despite being modeled after a meme and created as a parody. Of course, unsurprisingly, Dogecoin came crashing down in short order.
To avoid big losses when a can't-miss investment turns out to be a disaster, take the time to research the fundamentals.
5. Diversify your portfolio
Minimizing investment risks means not only understanding how investments work, but also ensuring you don't put all your eggs in one basket.
While you may have a particular company you love, if you sink your entire nest egg into buying its stock and it turns out the CFO was a thief who was cooking the books, you could lose everything.
To reduce the likelihood of big losses, spread your money around a mix of different assets. You could, for example, put some of your cash into big companies in the U.S., but also invest in emerging markets or real estate with the hope that if some of your investments perform poorly, others will do well.
If diversifying your portfolio and getting the right mix of different assets sounds complicated, you can opt to invest in target-date retirement funds that give you exposure to a mix of different assets appropriate for your age and goals. Roboadvisors can also help you build a diversified portfolio without requiring you to be hands-on.
Investing can be easy -- and it's important
Investing doesn't have to be hard if you start early, understand investment options, and invest in a mix of different assets to minimize risk.
By following these five basic investment rules, you can invest a lot in the right assets and maximize the chances you'll end up with a nice nest egg that will allow you to thoroughly enjoy your golden years.
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