Finance Lessons from Investing
Building wealth from saving money alone can be difficult. Saving up for a healthy emergency fund can be a great idea, but after having a few months saved up for unexpected expenses, investing is key. However, it's important to learn some lessons before investing any hard-earned money.
Diversification is a Winning Strategy
Investing in one company is riskier than investing in 10. Putting every egg in a single basket can lead to losing everything if the company goes bankrupt. It's unlikely that 10 companies will go bankrupt at one time. Therefore, it's a good idea to invest in several companies.
Index Funds Win
Using an index fund is an easy way to invest in multiple companies at once. Few active investors are able to beat indexes over the long run. Warren Buffett once bet leading hedge fund managers that he could beat their returns with a simple S&P 500 index fund. He won the bet. People who trade frequently tend to lose money to taxes. They also tend to buy high and sell low. Index investors passively follow the index, which allows them to avoid the problems that come with frequent trading. They also tend to achieve higher returns over time.
Avoid Excessive Greed
When other people get greedy, it's a good idea to take a step back. Warren Buffett says it's a good time to be fearful when the masses get greedy. When an investment has been on a great run, there's nothing wrong with taking some profits off the table. Those who are looking to retire early should build some cash to avoid the sequence of returns risk. Selling at a new peak can be a great way to build cash.
There Are No Sure Things
If a friend recommends an investment as a "sure thing," it probably isn't. It's likely an investment that's worth running away from as soon as possible. No matter how attractive an investment might seem, there is the possibility that it could go bust. Investors who find that their investments are going down will frequently fall victim to the sunk cost fallacy and refuse to sell even when their premise for buying fails to pay off.
Learning these lessons early can lead to financial success over time. Over the long run, diversifying and utilizing an index fund's benefits can lead to higher returns. When those higher returns compound over time, it's possible to build real wealth.