Here Are Some Important Investing Tips

Doing Well

If you are interested in making successful investments here are some tips that have paid off for me. There is no magic here. Just good, common sense. I promise I won't promise the moon. If you are looking for a "get rich quickly" scheme I am afraid this is not it. But I hope you'll read what I have to say.

Avoid 401(k) Plans

Let me ask you a question. Suppose someone kidnaps your family, demands that you pay them a ransom to get your family back, and then keeps one of your children after you pay the ransom. Will you be satisfied with the outcome of that transaction? That is what it feels like when you have to close out a 401(k) plan in an emergency. Although "tax-deferred investing" looks great on paper, the reality of this awful investment strategy is that it doesn't work for a majority of Americans.

In 2013 Time reported that 401(k) plans were "leaking" money. In 2014 the New York Times reported that Americans were withdrawing money from their retirement plans at a prodigious rate -- years before they were scheduled to. In 2015 CNN reported that millions of Americans were "raiding" their retirement plans. These are just examples I grabbed at random.

Why have 401(k) plans been such dismal failures? There are several good reasons. First, most Americans don't know how to manage their money. We make bad investment decisions all the time. We're not experts at playing the stock market but the way 401(k) plans are designed, you're responsible for your investment choices. Except your employer decides which funds are made available to you, and in most plans you don't get many choices. (On the other hand, I have read that even when presented with a lot of choices most people choose the wrong investments). We also tend to panic when the stock market takes a downturn, so we sell our funds at the wrong time.

But the worst thing about 401(k) plans is that if you have to make an early withdrawal just to pay your bills, the government not only taxes the withdrawal but throws in a 10% penalty for early withdrawal. This was the dumbest way for the government to manage the plans. The idea was to discourage people from withdrawing their investments too soon. Unfortuntely, the effect has been to deprive people of their hard-earned money when they most need it. If you ever wonder why it's so hard for Americans to save money, this is one of the reasons.

Only Invest in S&P 500 Index Funds

A lot of people now heed this advice and I really include it here only for the sake of completeness. I don't want to overlook the obvious. The S&P 500 index outperforms the rest of the stock market consistently, especially over 5-10 year periods. You may not be able to save money for 20-40 years but most people can hang on to some savings for 5-10 years. The S&P 500 index funds are your best bet for these kinds of short term investments.

No one needs to worry about which stocks are best to pick for these funds. They just maintain a balance of investments based on Standard and Poor's top 500 stock picks. The funds are managed by computers. These are called "Exchange Traded Funds" or ETFs for short. They have the lowest administration fees so they don't cost you very much money when you buy in or sell out of them.

Some people argue that you can make more money by picking individual stocks and mutual funds that outperform the S&P 500. But remember what I said above: research shows that most Americans are terrible at playing the stock market. We couldn't pick the best fund if you handed it to us on a silver platter. We're just not all financial experts and investing is a very difficult area of money management and wealth creation.

You probably won't find many choices of S&P 500 funds in your 401(k) plan. You may not find any. If you manage your investments outside a 401(k) plan you'll do better. Savvy investors agree that for the majority of small investors trading in index funds makes the most sense. There is just no better way to play the stock market with any realistic hope of long-term success.

Find Alternative Ways to Fund Investments

People don't realize just how expensive investing can be. You'll have to pay a fee to your broker every time you buy or sell stock or shares in a mutual fund. Even when you buy into or sell out of an Exchange Traded Fund you pay a fee to the broker. From the moment you begin playing the stock market the system is stacked against you.

Happily, I can report that a new way of investing has emerged thanks to the Internet. Virtually anyone with a bank account can now make inexpensive, infrequent, and small investments. This new method is called "microinvesting" and it works very simply. With as little as $10 per month you can begin buying into solid index funds. The way microinvesting works is that these companies pool the investments of many small investors when they make their purchases of shares in index funds. Hence, they buy big blocks of mutual fund shares.

You don't want to borrow money to make investments unless it's free. Warren Buffett uses "float" from insurance premiums to buy and sell options on stocks. He is literally investing with other people's money but keeping the profits for himself. True, he also incurs the losses for himself, but he made his billions by risking none of his own money.

You and I cannot borrow money from insurance premiums. We don't own insurance companies. However, there are times when borrowing money makes sense. Although I don't recommend borrowing money to invest in the stock market, if you come up short on cash for other needs you may have more options than you believe.

Practice Good Money Management

What you need to think about every month is how to manage your "cash flow". Cash flow is "what comes in (to your bank account) versus what goes out". Most of us keep this pretty close to a zero balance. In other words, we spend about every dollar we make. It's important to learn how to stretch your budget when paying your bills. You don't want to have to borrow money to pay your bills. That just drives you deeper into debt.

We want to achieve three things with our monthly budgets:

  1. Pay our bills on time
  2. Save some money on the side
  3. Leave a little for fun

When you look at it that way it sounds simple. But the truth is that it doesn't take long for most families to run up enough monthly bills that they first stop saving money and second stop having fun. The lack of savings makes you feel financially insecure. The lack of fun just makes you feel anxious and like a failure.

I really think we can all improve our money management practices. All you have to do is set aside a small amount of money each month. It adds up faster than you realize. If you only deposit $25 a month into a savings account you'll have over $300 at the end of your first year of saving money.

You might be thinkig, "Yes, and if I can save $25 I can save $50". But let's not get crazy here. The truth for most of us is that it's very, very hard for us to put back $50 a month and never touch that money. So the moment you can commit to saving $50 in any month, why not put $25 into savings and $25 into a microinvesting fund? That way you won't be able to drain your savings with one fell swoop.

I believe that by making it harder for us to remove all our money from our savings we'll ultimately save more money. You really just have to teach yourself to live within your means. Or, as some financial experts like to say, "Spend less than you make every month."