The worst thing a beginning investor can do is to try to predict the future performance of the market and invest lump sums of money in the next "hot" sector. Between 1998 and 2002, for example, the S&P 500 index grew at a rate of 12.2 percent a year. But during that same period, investors in sector-specific mutual funds received annual returns of 2.6 percent [source: Jenkins].
The only solid investment strategy is a long-term strategy. If you try to time the market -- only buying when you think the market has bottomed out and only selling when you think it's peaked -- you'll have to guess correctly three out of four times to equal the success of an investor who uses dollar-cost averaging over a long period of time [source: Jenkins]. Those are tremendously steep odds, considering that even paid experts are blindsided by completely unexpected market fluctuations.
The idea is to stick to the plan, even if the plan changes slightly as you get older. The ratios of your portfolio will slowly shift into more conservative investments as you accumulate more and more wealth. When you're ready to retire, you'll have less money in stocks and more money in bonds, because you want to safeguard your money from any last-minute drops in the stock market. When you first started, you had less money to lose and more time to recover from adverse fluctuations. But when you're retired, it's more important to have guaranteed income from low-interest, low-risk investments.
With all this talk of sticking to the plan, don't forget that it's OK to change courses if part of the plan obviously isn't working. For example, say you've had a mutual fund for 10 years and every year it's lost an average value of 3 percent. At this point, it's probably a good idea to shop around for a different mutual fund in the same sector with a better annual performance record. The important thing is to keep these changes to a minimum and be able to tell the difference between a temporary dry spell and an all-out drought. Your broker should be able to help.
For even more information on investing and personal finance, follow the links below.
Related HowStuffWorks Articles
More Great Links
- Janssen, Cory. Investopedia. "DCA: It Gets You In at the Bottom" http://www.investopedia.com/articles/01/090501.asp
- MSN Money. "A Beginner's Guide to Investing" http://moneycentral.msn.com/investor/beginnerguide.asp?page=introduction
- Jenkins, Richard. MSN Money. "Start investing with just $100" http://articles.moneycentral.msn.com/Investing/StartInvesting/StartInvestingWithJust100.aspx
- Kiplinger.com. "Control Your Risks" http://www.kiplinger.com/basics/archives/2007/08/investing3.html
- Kiplinger.com. "How to Start Investing." August 2007 http://www.kiplinger.com/basics/archives/2007/08/investing.html
- Fraud.org. "Investment Fraud." http://www.fraud.org/tips/internet/investment.htm
- McWhinney, Jim. Investopedia. "Dollar-Cost Averaging Pays" http://www.investopedia.com/articles/mutualfund/05/071305.asp
- Langager, Chad. Investopedia. "Start Investing with Only $1000" http://www.investopedia.com/articles/basics/06/invest1000.asp?viewall=1
- Investopedia. "10 Things to Consider Before Selecting an Online Broker" http://www.investopedia.com/articles/00/112100.asp
- Investopedia. "Advantages of Mutual Funds" http://www.investopedia.com/articles/basics/03/040403.asp
- The Motley Fool. "What Wrong with Full-Service Brokers?" December 21, 2007 http://www.fool.com/investing/brokerage/whats-wrong-with-full-service-brokers.aspx
- Investopedia. "Brokers and Online Trading." http://www.investopedia.com/university/broker/default.asp