I know what you’re thinking – the terms “stock market” and “winning investment strategy” don’t seem to go together. The stock market can be a volatile place to invest. (No kidding, right?) What many people don’t realize is this volatility can be used to your advantage, maximizing your gains over time.
If you put money into the stock market each month, ignoring the peaks and valleys in the Dow Jones, in the long run you’ll even the highs and lows. You might even make money. Let’s see how volatility can be used to your advantage:
The Value of Dollar Cost Averaging
Investing equal amounts of money in a stock or mutual fund each month reduces the risk of getting in at the top of the market and reduce the volatility that will always be a part of stock market investing.
A properly executed dollar cost averaging strategy can reduce the overall cost of your investments over time, providing more upside potential and reducing your risk of loss. Getting into the dollar cost averaging habit will also help to instill the discipline you will need to be a successful long term investor.
The Value of Diversification
To reduce the risk of the stock market and increase the odds of a superior return investors will need to create a widely diversified portfolio of stocks. Limiting your exposure to any one stock to 4-5% of your portfolio is one of the best ways to limit your risk, so you should try to build a diversified portfolio of between 20 and 30 stocks. As you the cash you have to invest increases, you can add more stocks to your portfolio.
If you do not have a lot of cash, you can purchase a widely diversified mutual fund instead. Mutual funds are the perfect way for small investors to get into the stock market with limited funds, so be sure to check out this option as well.
The Value of Controlling Costs
Investment costs can seem like a small thing in terms of an overall portfolio of stocks, but in fact those investment costs can add up pretty quickly. If you are to be successful in the stock market, you will need to control your costs at every turn. That means setting up an account at a discount broker, as well as keeping your trading to a minimum. Some discount brokers allow investors to buy and sell an unlimited number of shares for as low as $7, and that means you will have more money left over to invest.
Summary
By keeping your costs under control and focusing on the long term investors can take a great deal of the risk out of the stock market. While the stock market is still subject to some terrifying dives, it is also subject to some exhilarating climbs. By understanding the nature of the market investors can turn it to their advantage and make the most of every dollar they have to invest.
I know that I’ve not touched my stock since the market went crazy last year, and most of my stocks are back up to pre-summer of 2008. I even made money last spring in the stock market by continuing to put money away as if nothing had happened. (I must admit that I really didn’t know what else to do.) The stocks were very under valued last March, and some of them have triple in value since then.
Who else has a stock story they care to share? Did you sell when things were scary? Did you buy when stocks were low? Did you stay put and just not look at your 401K? Tell us by leaving a comment!
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As a person who has been investing for almost 20 years, I can attest to the money making power of the stock market. In the 1990′s, it was very easy to simply invest and watch the money grow. The votility we see now can be harder to stomach but I agree for those who have a long term horizon, there is a lot of opportunity. I would add that saving money on taxes is also crucial. Another good rule of thumb is to use an IRA account for income producing investments, and regular accounts for growth oriented stocks.
Traditional wisdom, like what you’ve outlined in this article, is not quite as correct as it used to be. Increased volatility in the market has made the traditional diversification/buy and hold long term model much more risky. Also, the assumptions that wisdom is based on is changing. It is becoming more important, in my 30 years experience investing in the stock market, that average investors learn how to manage their own portfolios. There are new investment vehicles such as ETFs and education on how to use options to reduce risk is more readily available. Average investors can protect their downside by simply learning how to place stop losses on their investments. One of the most valuable guidelines in investments that have paid off for me is never lose more that 4% of my portfolio on any trade. That requires active investing. You can’t assume a market will fully recover and restore your lost principle, especially in the same investment. Markets change and money moves around to different industries in a recovery.