As you read through these six tips, remember that the application of this advice will depend significantly on the specifics of your situation. Every decision should keep your overall financial situation in mind. When in doubt, seek the advice of a qualified tax professional and investment advisor.
Set Clear Objectives for Your Investments
You need to know exactly why you’re investing and what you expect of your money. Otherwise, you are going to be like a rudderless ship at sea—no direction and no purpose. Common investment objectives include capital appreciation, capital preservation, income, and speculation. An investment portfolio that aims to achieve capital appreciation will look much different than an income portfolio, for example, and they’ll perform differently over any timeline. If you aren’t clear about your goals, you could become disappointed in your returns. You might’ve followed the strategy perfectly, but you pursued the wrong objective.
Minimize Investment Turnover
As the saying goes, “don’t rent stocks, buy businesses.” If you aren’t willing to own a business for at least five years, don’t even consider buying shares unless you fully understand and accept that the short-term stock market is irrational, volatile, and capricious. Aside from the volatility, there are tax advantages to holding onto investments. The profits on long-term investments are taxed at a lower rate than short-term investments, and dividends from those investments are often taxed at a lower rate than distributions from recent additions to your portfolio.
Minimize Costs
Every dollar you give up in fees, brokerage commissions, sales loads, and mutual fund expenses is a dollar that can’t compound for you. While an expense ratio of less than a percent might not seem like much, it adds up over time. By finding ways to reduce your costs early on in your investment timeline, you could end up saving hundreds, thousands, or even millions of dollars by the time you retire.
Take Advantage of Tax-Efficient Accounts
Two great investment tax shelters designed for lower and middle classes in the United States are the Roth IRA and the 401(k). Both account types have tax benefits that can make them incredibly lucrative, but there are unique rules and contribution limits that must be kept in mind. You’ll also pay a penalty tax if you withdraw money from these accounts before age 59½ (though there are exceptions to this rule). A 401(k) plan allows you to invest in a variety of mutual funds, and employers may offer to match your contributions to the account. Whatever you contribute is deducted from your taxable income. You’ll pay taxes on the money when you withdraw it in retirement. By deferring taxes until retirement, you’ll likely pay fewer taxes, since your income (and income tax rate) will likely be lower in retirement. As far as taxes go, a Roth IRA is a kind of opposite to the 401(k) plan; money is taxed upfront, but it can be withdrawn tax-free in retirement. That means you don’t pay taxes on the capital gains, dividends, or interest your money earned as it sat in the Roth IRA.
Never Overpay for an Asset
There is no getting around it—price is paramount to the returns you ultimately earn on your investment portfolio. Stock prices fluctuate in the short-term, so even a good investment can be overpriced. This is where fundamental analysis comes in handy. By researching the details of the company’s finances, you can feel more confident in paying a fair price for a stock. On the other hand, a low price doesn’t offset an otherwise bad investment. You cannot buy a cheap stock with a low earnings yield and expect to do well unless you have reason to believe the company will grow significantly or experience a turnaround.
Diversify
Another classic saying offers some investment wisdom on this issue: “don’t put all your eggs in one basket.” Nor should you put all your money in a single investment. You may have heard that you should seek out high-quality blue-chip stocks with steady dividend yields, but you don’t have to choose just one blue-chip stock. You could easily find a dozen companies with similarly beneficial characteristics. By diversifying, you’re spreading your risk across different sectors, industries, management styles, and geographic regions. When something negative happens—a company goes bankrupt or a natural disaster affects industries in a certain region—the impact will only hit a segment of your portfolio. Sure, you will feel the negative effects, but not as intensely as you would have if you had put all your money in that one company or region.
