Should the Small Investor Be in the Stock Market?
As investors learned in 2008 -- when markets around the world crashed -- owning stocks can be financially hazardous. It's understandable that small investors may be fearful of buying stocks with their hard-earned money. Unfortunately, the time most small investors lose their fear, and decide to buy stock, is when the mood of the stock market resembles what Alan Greenspan called "irrational exuberance." Stock market investing should be done carefully and methodically. Buying just because everyone else is buying can lead to serious problems, but careful investors can overcome risk with a bit of planning.
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Inflation
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Every investment is subject to inflation risk. Cash is an investment too, and over time, it's subject to significant inflation risk. Investing in the stock market is considered risky by some, but the reality is, stocks have outpaced inflation better than every other major investment over time. For example, one dollar invested in the year 1800 would've grown to almost half a million dollars by 2002. By comparison, a dollar invested in bonds would've grown to just $1,000. Meanwhile, gold, adjusted for inflation, didn't grow at all.
Invest What You Can Afford
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While stocks are the best investment over time, the market can have some big ups and downs on a year-to-year basis. It's important to base your investment decisions on your timeframe. Never invest money you may need to use over the next few months. Likewise, money you'll need over the next year to five years, should be invested in guaranteed instruments, such as CDs, money market accounts, or bonds.
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Education
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Most Economics 101 classes teach an important principle -- there's no such thing as a free lunch. Successful investors aren't generally lucky. They take time to educate themselves before they put their money to work. The average person spends 40 or more hours a week working to make a living, but how much time do they spend learning how to make their money work for them? Investing in stocks can be highly rewarding, but it's important to learn how to invest wisely before buying stock.
Asset Allocation and Diversification
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While stocks have been proven to outperform all other investments, on a year-to-year basis they can underperform. Allocating your investments across several different asset classes, such as stocks, bonds and government treasuries, helps remove the short-term risk that exists in the stock market. Likewise, it's important to spread your money over a wide group of stocks, so your future performance isn't dependent on the fate of one or two companies. Buying a mutual fund is a good way for a small investor to diversify her investments.
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- Photo Credit investment image by Kit Wai Chan from Fotolia.com
