After five straight years of rallying, the stock market began to taper off late in 2015. The first week of 2016 was one of the worst stock market performances in a long while. If you are a new investor looking to start your investment program this year, you probably have some questions. Ask these questions before you start your investment program in 2016.
Is This a Good Time to Invest in Stocks?
If you are looking at the stock market during a steep decline, you may think it is a bad time to start investing. If you are looking at it when stocks are rallying, you may think it is a good time.
Actually, neither time is necessarily good or bad if you are investing for the long term (10 years or more). No one can predict with any degree of certainty which way the stock market will move at any given time; but over the long term, the stock market has always moved higher. Every bear market (when stock prices decline for a period of time) is followed by a bull market (when stock prices rise). Historically, bull markets have lasted much longer than bear markets, and the gains of bull markets have more than offset the losses in bear markets.
How Much Risk Should I Take?
One of the most important tenets of investing is the close relationship between risk and returns. Without risk, there can be no returns. You should be willing to assume more risk if you are seeking greater returns. In that respect, risk can be a good thing, but only if you allow for sufficient time to let the inevitable market cycles occur. Generally, if you have a longer investment time horizon, you should be willing to assume a greater amount of risk, because there will be more time for the market to work through the up and down cycles. Historically, patient investors have been rewarded with positive long-term returns.
New investors are often advised to invest primarily in mutual funds, which can provide instant diversification, offering the best way to reduce volatility. By investing in a few different mutual funds representing different asset classes (such as large growth stocks, international stocks or bonds), you can reduce volatility even further without sacrificing long-term returns.
If you are starting an investment program by investing incremental amounts of money on a monthly basis, you will benefit from dollar cost averaging. When you invest a fixed amount of money on a monthly basis, you buy some share prices at a higher price and some at a lower price due to market fluctuations. When the market declines, your fixed dollar amount will buy more shares. Over time, the average cost of your shares should be lower than the current market price. By using dollar cost averaging, your downside risk will be mitigated over time.
How Do I Choose Which Funds to Invest In?
The mutual fund universe is vast and expanding, which makes choosing among them very overwhelming. Use criteria to narrow down your choices; consider such things as costs, past performance, investment style and risk profile. Fund reviewers such as Morningstar offer tools for identifying funds that meet your criteria and performing side-by-side comparisons. As a new investor, the most important criterion should be cost. The cost of a fund, which can include a sales charge (commission), management fees and 12b-1 fees, can greatly impact the return you receive. There are several fund groups that offer good selections of funds at very low costs.
Vanguard Group is considered among the best fund families for offering low-cost, good-performing funds. Its website also offers online tools for helping you determine your risk profile and then matching it with the most appropriate mix of funds.
Who Should I Listen to for Advice?
Unless you have around $200,000 to invest, your choices for obtaining advice are somewhat limited. Large investors tend to work with independent investment advisors who charge flat fees for their advice. Small investors who want professional advice sometimes work with brokers from investment firms. Brokers typically charge a commission for every transaction they make. However, because brokers make their money from product sales or transactions, they may not be the most objective advisors.
As a new investor, you may be better off investing on your own. You can save on transaction costs; by working directly with a fund company, such as Vanguard or Fidelity, you won’t incur sales charges. Learn what you can about investing by doing your homework. There are plenty of online tools and resources available to investors for learning, planning and managing your investments. Tools available through the fund companies for monitoring and managing your investments are nearly as good as those offered by financial advisors and brokers. The real value an investment advisor can offer is to help you avoid mistakes and keep you focused on your long-term investments. If you develop the necessary patience and discipline on your own, you are way ahead of the game when you call on the services of an advisor.
What’s the Best Way to Get Started?
Do your homework. You don't have to be in a rush to start your investment program. The most important aspect of investing is to know yourself – your goals, your preferences and your tolerance for risk. Use your own investment profile as a starting point to research the types of investments that are suitable for you. Start with a small portfolio of three or four funds from different asset classes that can provide you with fairly broad diversification. As your understanding of different asset classes and fund types increases, add to your portfolio according to your investment profile and your long-term strategy.