No matter what happens in the stock market, Laura covers 8 rules for investing wisely without taking too much risk. Learn how much you should invest and where to put your money so you create financial security even when the stock market drops.
After seeing last week’s huge stock market drops, you may have wondered if you’re investing money the right way. Or you may still be on the sidelines, not sure how or when it will be a good time to get in the game.
I received a question from Sagar R. who says, “I have a unique situation. I’m 35 years old, from another country, and have never invested. I fear recession is around the corner every year and just put my money in the bank. How can people like me get started investing?”
Another question comes from an anonymous Money Girl Podcast listener who says, “I have about $50,000 sitting in a savings account. I haven’t put it in an IRA because I’ve been worried that I’ll need the money. But I’m also worried that I’ve waited too long to start investing because I’m in my 40s. How should I manage this money?”
In this post, I’ll answer these questions with recommendations for how to invest money wisely, even when the market is volatile. You’ll know exactly how much to invest and where to put your money so you create financial security without taking too much risk.
8 Investing Rules to Follow Even When the Stock Market Drops
- Clarify the purpose of your money.
- Know the difference between saving and investing.
- Start early and small.
- Don’t try to beat the market.
- Be diversified to cut risk.
- Focus only on what you can control.
- Use tax-advantaged accounts for faster results.
- Choose investments based on time horizon
Here’s what to know about each investing rule.
1. Clarify the purpose of your money.
There’s one rule of investing that you should always remember: Never expose money to more risk than is necessary to accomplish your goals. So, take a step back and be clear about why you’re investing in the first place. Determine when you’ll need to spend the money you plan to invest, because that determines what you should do with it.
Historically, a diversified stock portfolio has earned an average of 10%. But even if you only earned an average of 7% on your investments, you’d have over $1.3 million to spend during retirement if you invested $500 a month for 40 years.
But if you save $500 a month in a bank account with an average return of 0.5% over 40 years, you’ll only accumulate about $250,000. So, if your long-term goal is to have a nest egg that allows you to pay for retirement, keeping money in a safe place—like a savings account or a low-yield CD—simply won’t get you there.
The reality is that not taking enough investment risk can be the riskiest move of all! You could fall short of your goals or run out of money during retirement.
If there was no risk to getting a big return on your money, everyone would run to the highest-yielding investments. But high return investments usually bring higher risks, so they need to be used carefully.
In other words, investing means that you could possibly lose money. This risk creates a tension that keeps many people from getting started investing in the first place.
Also, consider that in the past couple of years, the inflation rate has been more than 2%. So, if you’re not earning at least that much, you’re really losing money.
Therefore, taking calculated investment risk is an important part of your financial life. Without it, your money won’t grow fast enough to achieve your long-term goals. Keeping money safe and cozy in a low-interest savings account stunts its potential and doesn’t give it the opportunity to grow.
The reality is that not taking enough investment risk can be the riskiest move of all! You could fall short of your goals or run out of money during retirement. Whether you avoid risk intentionally or have simply been procrastinating investing, the result could be devastating to your financial future.
2. Know the difference between saving and investing.
Though we tend to use the terms saving and investing interchangeably, don’t confuse them. Here are the major distinctions between the two:
- Saving is putting money aside without exposing it to any or little risk, such as in a savings account, money market deposit account, or a certificate of deposit (CD).
- Investing is committing money to an endeavor or account with the expectation that you’ll make a certain amount of profit or income. The risk is that you’ll receive less than what you expect. Or worse yet, there’s a possibility that you could lose your entire investment.
As I mentioned, the timing for spending money determines what you should do with it. Money that you want or might need in less than five years should not be exposed to market volatility because it’s value could drop at the exact moment you need it.
So, even though safe, low-yield options—such as a bank savings or a money market deposit account—are poor choices for your long-term goals, such as retirement, they’re perfect for your short-term goals and emergency savings.
Money that you want or might need in less than five years should not be exposed to market volatility because it’s value could drop at the exact moment you need it.
Before you do any investing, your first financial priority should be to accumulate emergency savings. That’s how you avoid getting into financial trouble if you have a large, unexpected expense or lose your job or business income.
Ideally, everyone should have a minimum of three to six months’ worth of their living expenses tucked away in an FDIC-insured bank savings account. If that amount seems unattainable, start by saving a reasonable amount, such as $500 or $1,000. Then build it while you invest for the future at the same time.
The ideal scenario is to invest a minimum of 10% to 15% of your gross income for retirement, plus an additional 10% for emergency savings. Consider these amounts monthly obligations to yourself, just like a bill with a due date you receive from a merchant.
If saving and investing a minimum of 20% of your gross income seems like more than you can afford, start tracking your spending carefully and categorizing it. I promise that when you see exactly how you’re spending money, you’ll find opportunities to cut back and save more.
Let’s get back to the anonymous question about having $50,000 sitting in a savings account. Whether you should move some amount into investments depends on how much emergency money you need.
If you feel comfortable having less on hand, you could use some of it to max out an IRA. For 2018, you can invest up to $5,500, or $6,500 if you’re over age 50, in a traditional or a Roth IRA. Or you could leave the savings alone and begin making contributions to a retirement account now.