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My five golden rules of investing

My five golden rules of investing

There can be a lot to think about when investing in the stock market, and the advice you can find online is often extraordinarily contradictory.

As a result, it can be easy to make common mistakes when you start investing for the first time, or even if you’re an experienced investor with many years under your belt already. That’s why I’ve put together these few simple rules to help you make informed decisions about your investments.

These tips are far from the only way to invest, but they’re certainly a good example of choices you can make that can help to manage risk and set you on the right path towards returns.

Many investors develop their own rules and strategies over time. Even so, to increase your chances of investment success, it can be useful and prudent to read around other techniques to make sure that you’re not missing out or accidentally putting yourself in a position that could see you lose money.

So, whether you’re a novice investor still in the early days of investing in the market or you’re a veteran checking that you’re on the right track, read my five golden rules of investing.

1. It’s time in the market, not timing the market

The first rule that you should be aware of is how valuable taking a longer investing horizon can be. In other words, rather than trying to time the market, the best results are often achieved from time in the market.

Often, investors think that the best way to target potential returns is trying to predict market movements and then buy and sell accordingly. The trouble is that, unless you have a crystal ball, no one can predict the future. This is bad news if you’re basing your investment decisions on what you think might happen in the markets over a short period.

Instead, it’s often best to focus on a longer horizon for your investments. Rather than trying to capitalise on rises and falls, it can be sensible to generate slow, steady returns by investing in the market for a prolonged period.

In fact, according to research by investment platform Nutmeg, investors who held stocks in the market between 1971 and 2020 never lost money if they invested for 13 and a half years or more.

Experts often recommend an investing horizon of at least five years. That way, you’ll give your investment sufficient time in the market to start generating returns.

Using a robo-advisor

If you’re unsure how to design a portfolio to invest for the long term, you could consider using a robo-advisor to do so instead.

Using a robo-advisor, you can set up an automatic, regular investment that’s suited to your goals, based on a survey that you fill in when you first sign up for the service. Doing this essentially allows you to set and forget your investment strategy, leaving your invested funds to grow over time in the background.

You can read my guide to the best robo-advisor platforms to find out more about robo-advisors and whether they’d be a good option for you.

2. Don’t put all your eggs in one basket

My second golden rule of investing is to spread out risk by not holding all your eggs in one basket. This is the value of an investing concept called “diversification”. Diversification helps to ensure that you’re not overly invested in one area. This is important because, if you held all your money in one company and its value fell, your entire portfolio would fall with it.

Instead, it’s often a good idea to spread your money out across different regions, sectors, and asset classes. A good rule of thumb to follow here is the “5% rule”, in which no more than 5% of your entire portfolio is invested in one company, sector, or area.

Geographical locations

Choosing investments across different countries and regions can help to avoid your investments being affected by the same economic or political changes. For example, investments in other countries and regions will be subject to different pressures than UK stocks. So, if your UK investments all fell because of national circumstances, your investments in other countries might not.

Sectors and industries

As well as other locations, it can also be sensible to consider different sectors and industries. For example, an oil company’s price will be affected by different factors than one that produces wind turbines or solar panels. This can help to lower the chances of all your stocks losing value at once.

Asset classes

Another way to diversify your portfolio is to consider your asset allocation. An asset class simply refers to the type of asset that you’re buying. There are many different asset classes you might consider, but common ones to consider spreading your money out in are:

  • Stocks and shares in companies
  • Bonds, including corporate and government bonds
  • Commodities, such as gold and silver
  • Real estate, whether that’s physical property or through real estate investment trusts (REITs)

Holding a range of different assets can further help to spread out risk.

3. Dividend-paying stocks can be transformative

My third rule is to consider investing in dividend-paying stocks and shares. A dividend is a payment that companies give to shareholders as a reward for holding shares in them. These are typically paid out as a portion of profits, reflecting a company’s performance in a certain period.

Dividends can be useful as they offer you the chance to earn a passive income from your investment, even if the stock you’re holding hasn’t risen in value. You can then take these dividends as profits or reinvest them in more stocks and shares, further boosting your holdings without having to invest any more of your cash.

Over time, dividends can really add up, giving you an alternative source of income in your portfolio. Consider including some dividend-paying companies so that you can add this extra quiver to your portfolio’s bow.

4. Steer clear of the hype and the herd

My fourth rule is an incredibly important one, but also one that can be difficult to follow. This is to steer clear of investment hype and to avoid following the herd.

Think of the GameStop short from the start of 2021. Many investors piled into this opportunity as it become popular, with the gaming shop’s share price rising to remarkable highs of nearly $350 a share. Unfortunately, many of the individuals who then bought this share arrived too late, ultimately losing out as early investors sold their holdings and the price quickly fell.

The herd can be wrong. If you’re considering an investment that’s become popular in this way, make sure you do your own research first so that you know whether it’s a worthwhile opportunity for you.

Buying when everyone else is fearful

Indeed, rather than following the herd, Warren Buffett, a titan of the investment and financial services world, once said that investors should be “fearful when others are greedy, and greedy when others are fearful.”

What Buffett was saying is that smart investors are those who avoid the herd and find investments that others aren’t targeting, looking to capitalise on market movements this way.

Buying what you understand

Interestingly, Warren Buffett also once advised investors to only buy what they understand. In this case, his point is that investing in things you don’t understand means you can end up buying the wrong thing.

Again, think back to the GameStop short. There was no doubt potential to make money here, but many people who didn’t understand the concept of “shorting” a stock may have ended up losing money as they might not have known how to manage that situation.

Always make sure you do your own research and know exactly what it is that you’re buying. That way, you’re more likely to know how to manage your investment.

5. Never invest more than you can afford to lose

As you no doubt know, investing involves risk. That’s why my fifth, and perhaps my most important rule, is to never invest more than you can afford to lose.

While data shows that investing for the long term has provided returns in the past, there’s simply no predicting exactly what will happen in the stock markets, and there’s always a chance that you’ll come out with less money than you went in. That’s why you need to only invest money that you can afford to lose entirely.

Never invest money that you need for living your daily life, such as paying bills, and be willing to accept that you may lose your entire investment.

Keeping an emergency fund

If you’re concerned that you’ll end up putting too much of your money in the market, a good way to avoid this is to keep a pot of money away from the stock market in cash.

It makes sense to keep at least six months’ worth of expenses in this account. That way, you can be sure that you and your family will always have money to live on, no matter what happens in the markets. Keep this money in an easy-access savings account so that you can get to it quickly in the event that you need to.

Bonus rule: set your investment strategy to your goals

While the five tips I’ve already given you are my main golden rules for investing, I also have to include this bonus rule which is to align your investments with your wider financial goals.

Whether you’re targeting returns for buying a home or a car, or you’re trying to build a nest egg for the future, always invest with your goals in mind. That way, you can tailor your investments so that they’re pulling together in the right direction towards your targets.

Taking financial advice

If you need help designing a portfolio that’s aligned with your wider financial goals, you may want to consider taking advice from a professional planner or advisor. Financial planners and wealth advisors can provide personalised information on the investment products and assets that are most suitable for you and your circumstances, designing a diversified portfolio that works for you.

They can help show you where you might be taking on too much risk, and provide suggestions as to where you could refine and improve your strategy so that your investments are even more effective in helping you to achieve your goals.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.

Frequently asked questions

What are the five golden rules of investing?

My five golden rules of investing are:
1. It’s time in the market, not timing the market.
2. Don’t put all your eggs in one basket, and diversify your investments.
3. Dividends can be transformative.
4. Steer clear of the hype.
5. Never invest more than you can afford to lose.

What is the 5 percent rule in investing?

The 5 percent rule in investing is that investors should invest no more than 5% of their total portfolio in a single investment. This rule is designed to encourage diversification so that investors do not end up overly invested in one position.

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