The Most Important Rule of Investing
There's one golden rule that you should always keep in mind and observe when you're investing: Never invest money that you can't afford to lose.
Saving vs. Investing
Investing is not saving. There's a significant difference between saving and investing. The short explanation is that saving is putting money aside in a safe place where it stays until you want to access it in a few days, a few months, or even several years. It might earn a little interest depending on where you put it, and it will be there for you in case of an emergency or to achieve the goal you're saving for.
Investing is the process of putting your money to work for you. When done properly, it can typically make more money for you than the interest you might earn in a nice, safe savings account or certificate of deposit. But with reward comes risk. If you make poor choices or even if things beyond your control go wrong, you could lose that money. It might not be there for you in case of an emergency.
Investing vs. Gambling
If you always remember the "never invest money that you can't afford to lose" rule and never violate it, you shouldn't have to worry about eating cat food during your retirement or if something potentially catastrophic occurs like job loss or illness. Worse than investing before you've established savings is the prospect of investing money, you need to meet other responsibilities, which can be catastrophic.
There's a natural human tendency to want to overreach, to put in more money than you can afford and go for a huge payout and that brass ring. This trait tends to become magnified; the more desperate someone is for money. He harbors the hope that hitting the jackpot will make all his problems go away. Many people below the poverty line are playing the lottery, but not many executives drop their money on tickets.
Guarding Against Investment Risk
You can't just look at your portfolio as the stocks you own. A portfolio encompasses so much more—your emergency cash reserves, your insurance coverage, your funded retirement accounts, your real estate holdings, and even your professional skills that determine the income you can potentially earn should you lose your job and have to start over.
You can avoid the pitfalls of what we call the refrigerator problem by keeping your eyes on the big picture. The same folks who spend weeks studying Consumer Reports ratings for a new stove or refrigerator will sometimes put all their savings into a stock or other investment that they don't entirely understand, without doing any real research, and this doesn't make any sense.
Your first goal should always be to avoid major losses.
- Don't get greedy
- Be patient
- Seek the advice of qualified, well-regarded advisors
- Keep your costs low
This recipe may not seem very exciting, but it's been proven to work for generations again and again.