Which way is the market heading and are my investments the right ones to be holding right now?  Investors who play this game try to time the sale or purchase of a particular investment in order to reduce their losses and increase profits.  While maximizing return is an admirable investing goal, successfully predicting the direction of the market or even an individual stock’s price requires skill, luck and a whole lot of nerve, and it’s a strategy that rarely pays off.

12 Strategies For Success

So how does the average investor protect their money when it seems like the rules are stacked against them?  Consider these 12 strategies:

(1) Be wary of any stock or investment you read or hear about promising huge returns.  Returns are a function of risk—the higher the promised return the higher risk.  That means your chances of winning big are offset by your chances of losing some or even all of your investment.  It’s also worth remembering that stocks or funds performing well one year can fall as much or more the next, so don’t rely on past performance alone to make investing decisions.  To avoid unnecessary risks, find out what risks are unique to an investment before you buy into it.

(2) Keep abreast of the developments in the markets, but don’t get overwhelmed by them.  Almost every day, you can find someone predicting the beginning of the next bull market run and someone else predicting the demise of the current one.  However, it’s rare when the overall market shifts more than a percent or two in a day and rarer still when trying to time the market pays off.  Human psychology works against us.  The tendency is to buy after prices have gone up and sell after they’ve gone down.  To avoid this, develop a disciplined long-term approach to investing.

(3) When buying stocks or funds don’t just consider price—also factor volume into the equation.  If there is low volume (i.e. the number of shares traded on average is small) then in any given downturn finding buyers may be harder.  That can translate into bigger losses.  This can be especially true of certain small or micro cap stocks or newer exchange traded funds (ETF’s)  that have yet to build a market following.  Look for shares or funds with average traded volumes in the hundreds of thousands or even millions of shares to ensure sufficient demand.

(4) Be very skeptical of any investment advisory newsletter promising fantastic returns.  According to Mark Hulbert of the Hulbert Financial Digest (a paid subscription service that ranks newsletters) over 80% of newsletters fail to beat the S&P 500 average over the long term.  Yes, you may get lucky for a year or two but all advisers ultimately face the law of averages.

Do you have debt? Pay it off first.

(5) Don’t invest more than you can afford to lose.  In other words, make certain you are paying for the items in your family budget before you invest in the markets.  Think of it this way: Paying off a credit card with 15 to 25% annual interest is as better than picking a winning stock with the same kind of return because there’s no tax on your gain!  Also, consider averaging in and averaging out of the market.  In other words, rather than try to guess whether it’s a good time to buy or sell, split your investment funds into equal chunks and buy or sell this smaller portion at regular intervals.  This is called dollar cost averaging and it avoids some of the risk of buying high or selling low.  Some stock brokerages are better at helping you minimum commissions with this than others.  Check out Sharebuilder.com (check their discounted trading program) or FolioInvesting.com (check their window trading program) to learn more.

(6) Don’t put all your eggs in one basket.  In other words, diversify your investments across a wide spectrum so you can avoid a big loss in any one type.  For more on this subject read our post, “Diversification: A Safe Money Machine”.   One other note:  If your spouse or partner also invests in the markets then look at the combined picture of diversification across all of your investments.  Otherwise, you could be much less diversified than you realize.

(7) Before you buy in, determine how much you are willing to lose on an investment.  Will it be 5%, 10%, 20% or more?  Once you know what you are willing to risk, set up an automatic stop loss order—a price you intend to sell at if the market takes a tumble.  You can arrange for your broker to handle this, or if you have an online brokerage account, you can set the stop yourself. To avoid stopping out unnecessarily, study the volatility of your investment first.  A stop loss avoids the need to try and time the market.  Think of it like a circuit breaker designed to prevent a fatal shock if market conditions turn against you.

(8) Consider “hedging” some of your investments by using “inverse” funds.  For example, if you invest in long term government bonds and are worried that long bonds are facing a potential bubble, you might also buy an inverse long bond exchange traded fund which will perform in the opposite direction of long bond prices.  If you decide to “stabilize” your portfolio this way, invest no more than 5% to 10% in correlated inverse funds, and set up a stop loss, too. A note of caution:  Avoid inverse funds that double or triple market averages without understanding the higher risks involved.

Guard your money. Don't invest it until you're ready.

(9) If you aren’t sure how to invest or what to invest in, take the time to research your options.  Don’t worry that if you don’t invest now, it will be too late.  There’s always another opportunity somewhere.  Learn before you leap.  There is a ton of information available on investing on the internet.  Check the Yahoo or Google finance pages to get started.

(10) All investing holds certain risk, so figure out your tolerance for loss.  If you know up front you won’t be able to stomach a big loss, then you’ll want to seek out much more conservative investments.  On the other hand, if you’re young, have a long investment horizon and are willing to risk a little more, than you might seek to invest more aggressively.  For more on this topic, read our post, “What Kind Of Investing Is Best?”

(11) It’s very hard to recover from big losses, so if you’re nearing retirement, consider shifting your money into more conservative investments.  For more on this topic read our posts, “A Key Secret To Investing” and “Plan For Retirement Now.”

(12) Keep it simple.  Holding a host of stocks or other investments requires following and analyzing each and every one.  If you’re geared up for it great.  Otherwise, stick with a simple investing strategy.  For example, you might buy an ETF or mutual fund that covers the broad market, or you might buy into a specific market segment rather than hold a dozen different individual stocks in that same segment.  For more on some simple time-tested strategies read our post, “The Lazy Investor”.

A Word On Risk

Please remember, all investing involves risk, meaning you can lose some or even all your capital if the situation gets bad enough.  At the same time, risk is the main driver for reward, and fortunes are built on it.  This makes it critical to understand your unique tolerance for risk and decide on a specific investing strategy that suits you.

By Bob Anderson
© 2011 Javabird LLC.  All rights reserved.

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Don’t have a savings plan?  Read:
How Much Should I Save Every Month
Teach Your Kids To Save

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