Basic Rules for Investors
It's important to make the most of your investment dollars. For those who are new to investing, here are some tips from the Michigan Association of CPAs.
- Have a plan. Thorough planning based on clear financial goals is the key to successful investing. Whether you are investing for retirement, a down payment on a house, or for your child’s education, assigning time frames to your financial goals will help you determine the appropriate type of investment. For example, if you plan to buy a home in the next two years, you’ll need to invest more conservatively than you would if you were investing for your toddler’s college education.
- Understand asset allocation. Asset allocation is the process of dividing your investment dollars among the three main types of investment categories — stocks, bonds, and cash/cash equivalents. CPAs emphasize that having the right mix of assets is the single most important predictor in determining the overall performance of your portfolio.
- Diversify, diversify, diversify. In its simplest terms, a diverse portfolio is one that contains different types of investments within each of the major asset classes. While you can’t completely avoid risk in investing, spreading your money among a number of different types of investments can help reduce your level of risk.
- Know your risk tolerance. Generally, when investing, the greater the risk, the greater you should expect the reward to be and conversely, the lower the risk, the lower the return. Examine how much risk you are comfortable with. And remember, not every investment is for every investor. If an investment is likely to cause you to lose sleep, it’s not the right investment for you.
- Investigate before you invest. Do your homework. Follow the time-honored advice and invest in what you know. If you’re buying stock, start with companies in industries you’re familiar with. You can make more informed investment decisions when you understand a company's products, market, strengths and weaknesses, and competitive pressures.
- Invest for the long term. Pick your investments well and give them enough time to perform. Frequent trading drives up your portfolio’s overall transaction costs, which can lower your returns. When you invest for the long term, you may be able to save money on taxes by qualifying for the lower long-term capital gains tax rate.
- Always read the prospectus. It’s important to understand the risks, costs and liquidity of any investments you make. If you have questions, ask your CPA or investment advisor.
- Don’t invest solely on past performance. Past performance does not predict future results. Choose your investments based on your financial goals, risk tolerance, and time horizon and align these with your asset allocation and diversification strategies.
- Don’t fall in love with an investment. No matter how much you like a product or admire a company’s CEO, when a company stops looking like a good investment, give it up. An emotional attachment to a particular investment may prevent you from being objective.
- Avoid "get rich quick" schemes. If an investment seems too good to be true, it probably is.
- Buy and hold; don’t buy and forget. Companies and markets change. Monitor your investment portfolio regularly and make adjustments to keep your portfolio in line with your financial goals.
- Ask for help. A CPA can help you to determine how to add investing to your overall financial plan.