The Stock Market can be a scary place for uninformed investors. With the emergence of mobile investing applications, like Robinhood, it is becoming easier than ever to invest your money. This sounds like a good thing, but it is a double-edged sword. Those who are new to stocks can invest without doing research, which leads to money being lost. While the Stock Market can be a place to increase your wealth, you must research thoroughly beforehand. This guide will tell you the basics of minimizing your risk in the stock market. We will go over which investment types are best for you and some strategies you can use to make sure your money is safely invested. Let’s take a look at how to minimize your risk in the stock market!
It may seem overwhelming for investing beginners to see all the different options you have to invest in. It can be sticky to find out what everything means! Let’s go through a couple of these options you can use and why they are low risk.
If you take away one thing from this guide, remember this. Index Funds are the most effective way to minimize your risk. You may also see an Index Fund called an ETF (Exchange-Traded Fund). Index Funds and ETF’s are basically the same thing, the main difference being that ETFs can be bought and sold throughout the day, whereas Index Funds can only be bought or sold at a set price at the end of the day.
So, what is an Index Fund? An Index Fund is a portfolio or collection of stocks. When you buy into an Index Fund, you are buying a small percentage of each stock in that Index Fund. Let’s say you are investing $1. If you buy a stock with that $1, you will get 1 stock for $1. If you put that $1 into an Index Fund or an ETF, then you are really putting a couple of cents into each stock in that Index Fund.
Index Funds and ETF’s reduce your risk in the Stock Market as they diversify your portfolio. You’re technically not just buying 1 stock, but a whole bunch of them. This means that if 1 stock in the Index Fund is going down, it’s not the end of the world because the others may be going up.
Still not convinced? In 2008, world-renowned investor Warren Buffet made a million-dollar bet to the hedge fund industry (many people who invest in stocks for a living). The bet was an index fund would outperform a hand-picked portfolio of hedge funds over 10 years. I think you can guess who won that bet with how highly I have spoken on Index Funds!
Your 401k will most likely be the highest of your investments. This is your main retirement account. Most financial institutions suggest that you put aside at least 15% of your salary into your 401k. Your employer will have their own 401k retirement account. Be sure to ask about it during your hiring process. Companies will match a certain percentage to put into your 401k. When putting money into your 401, be sure that, at a minimum, you are putting in enough to get your full employer match.
IRA means Individual Retirement Arrangement. As the name suggests, this investment is outside of your employer-sponsored retirement plan. Having a Roth IRA means that all profit you make in the account is tax-free. This is because you pay your taxes upfront on the money you put in. So, when you take out your Roth IRA money for retirement, you will get exactly what you have. No taxes paid. When you put money into a Roth IRA, you are typically investing in Index Funds. With this being a retirement account, you cannot take any money out without penalty before you are 59 years old.
This article on Forbes demonstrates the power of a Roth IRA, showing how you can become a millionaire by just contributing to a Roth IRA. “If you start at 22, you can become a millionaire by only contributing to a Roth IRA. Assuming an 8% average net return, you would need to save only $2,600 or so per year to retire a millionaire at 67. Of course, you should save more if you want to retire early or become a multi-millionaire.”
Now you understand what types of investments to make to minimize your risk, let’s learn some strategies you can use while investing to make sure your money stays safe.
Dollar-Cost Average is an investment strategy you can use to minimize your risk for long-term investing. To do this, instead of putting all your money in at once, spread it out throughout a period of time.
Dollar-Cost Averaging’s basics are if you buy a stock at $5, then repurchase it at $4, your dollar cost average will be $4.50. This means if the stock price is above $4.50, then you will be profiting. Now imagine it on a larger scale.
The Dollar-Cost average strategy minimizes your risk because it reduces the risk of making a badly timed choice to invest in a particular stock. Let’s say you decide to invest all $1000 into Visa, and by next month Visa has dropped $50. You’ve just lost a whole lot of money. Instead, if you had invested $200, and then $200 the next week and so on, your dollar cost average would have reduced your average price, and you would have lost a lot less money.
If you regularly contribute to your 401k or a Roth IRA, then you are using Dollar-Cost averaging to your advantage.
Have you ever heard the saying, ‘Don’t put all your eggs in one basket’? This is the same concept. Don’t put all your money into one industry. If you only invest in one industry, and that industry has a bad month, then all your stocks will go down. Instead, try to spread your investments throughout a variety of industries and sectors. You reduce your risk of losing money if one industry has a bad month.
And there you have it. Invest in Index Funds, take advantage of your employer’s 401k contributions, and regularly invest in your Roth IRA. Using these investments, on top of diversifying your portfolio and using Dollar-Cost Averaging, will ensure your risk in the Stock Market is minimal. Happy trading!
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