There is no perfect investor or investment strategy, but there are definitely smart ones. Different strategies will suit different people for a variety of reasons, but there are some tried and true investing techniques that can benefit every investor. Here are four things you can do to become a smarter investor.
1. Use index funds
Equity indices are used to group companies based on certain criteria, such as market capitalization, industry, or ESG mission. Index funds are made up of different financial institutions to reflect a specific index. As an investor, using index funds is one of the best things you can do because it allows you to achieve instant diversification. With just one investment, you can invest in multiple companies at the same time.
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Take the S&P 500 Index Fund as an example Vanguard S&P 500 ETF (NYSE: VOO). With just one investment, you can gain exposure to 505 of the market’s best-known and largest companies. While the top three sectors in the S&P 500 are information technology, healthcare, and consumer discretionary, the index covers just about any industry you can imagine.
2. Understand the power of compound interest
It’s one thing to make money from your investments; it’s another thing to let the money you earn from your investments start earning your own money — that’s where compound interest comes into play. The sooner you start to understand the power of compound interest in investing, the more profitable it will be. All you need is time and compound interest does the rest.
Let’s imagine a scenario where you make a one-time investment of $10,000 in a fund that will return 10% annually over the long term. Here’s what the investment looks like after different years:
- Value after 20 years: $67,200
- Value after 25 years: $108,300
- Value after 30 years: $174,500
This shows how much value can be added with just more time. Over time, the total increased more than the previous year because more money was earned in return. In the first year, you earn 10% of $10,000; in year 15, you earn 10% over $41,000; in year 29, you earn 10% over $158,000. The more time the better.
3. Know what you pay
While allowing free trading is now the industry norm, investors still need to be aware of some fees. Any fund will have an expense ratio, which is an annual fee charged as a percentage of the total investment amount. For example, an expense ratio of 0.50% means you pay $5 per year for every $1,000 invested. While the percentage differences between funds may seem small, over time they can add up and take away your gains.
Smart investors should also be aware of their 401(k) plan charges. These fees are often overlooked, and many people are surprised to find out how much they are paying in their 401(k) fees. Part of the reason 401(k) fees become expensive is that they are multi-level. You will pay the plan provider an administration fee, fees for funds held in a 401(k), and even service fees for other features or services you may choose to use. Find out how much your 401(k) costs.
4. Know that all damage is not worth waiting for recovery
It is usually in your best interest to be a buy-and-hold investor in long-term investments.However, one thing you have to realize is that some losses may never be recovered, even if They will recover in the future, and the opportunity cost may not even be worth the wait. Sometimes sticking to an investment can hurt you more than giving up.
Losing an investment is never a plan, but sometimes you can find a silver lining. Just like you can use capital losses to offset any taxes you may owe on capital gains. You can deduct up to $3,000 per year from any capital losses that you own in excess of capital gains. For example, if you sold some stock at a profit of $3,000 and then lost $5,000 on an investment, you can deduct $2,000. If your losses exceed the $3,000 deduction limit, you can carry forward the excess to future years.
Smart investors know when to move on.
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Stefan Walters holds a position in the Vanguard S&P 500 ETF. The Motley Fool owns and recommends the Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.