4 Secrets Every New Investor Must Know

Photo culled from E15initiative.org

1. The Earlier You Start, the Easier It Is to Build Wealth Thanks to the Power of Compounding

You've probably heard this a million times but it's important that you truly internalize it in a way that changes your behavior and reorders your priorities. You will end up far richer if you begin investing early. It's all due to compound interest and the outcome differentials are staggering. For example, an 18-year-old who jumps straight into the workforce and saves $5,000 a year in a tax shelter such as a Roth IRA , earning long-term average rates of return , would end up retiring with $4,359,874. For a 38-year-old to achieve the same thing, he or she would need to save more than $36,000 per year.

To become a believer, read how a recent college grad could end up with $4,426,000 by saving $111 per paycheck throughout his or her lifetime or how to improve the quality of your life by using the time value of money formulas, both of which explain the formula in detail.

2. No Matter What People Say, There Are No Silver Bullets — Tailor Your Portfolio to Your Unique Life Circumstances, Objectives, Risk Tolerance, and Goals

People have a tendency to get emotionally involved in their holdings, sometimes even worshiping a specific legal structure, methodology, or even company.

They lose their objectivity and forget the adage, "If it looks too good to be true, it probably is." If you come across an offering positioned as "This is the only stock you'll ever need to buy," or "Buy these three index funds and ignore everything else," or "International stocks are always better than domestic stocks," run for the hills.

You have a job to do as the "manager" of your investment portfolio. That job depends on various factors including your personal goals, objectives, resources, temperament, psychology profile, tax bracket, willingness to commit time, and even prejudices. Ultimately, your portfolio should take on the imprint of your personality and unique situation in life.

For example, a wealthy, well-heeled former private banker capable of reading an income statement and balance sheet may want to collect a six-figure passive income from dividends, interest, and rents resulting from lovingly putting together a collection of blue-chip stocks , gilt-edged bonds, and trophy commercial buildings. A young worker may want to buy the cheapest, most diversified, most tax-efficient collection of stocks through a low-cost index fund in his or her 401(k). A widow leary of the stock market gyrations may want to acquire a portfolio of cash-generating rental houses with surplus funds parked in certificates of deposit .

None of these options are wrong or better than the others. The question is whether the portfolio, methodology, and holding structure are optimal for whatever goal you are attempting to achieve.

3. You Will Experience Several 50 percent Drops In the Market Value of Your Portfolio Over an Ordinary Investment Lifetime.

Asset prices are constantly fluctuating. Sometimes, these fluctuations are irrational (e.g., tulip bulbs in Holland). Sometimes, these fluctuations are caused by macroeconomic events. For example, mass markdowns on securities due to investment banks hurling toward bankruptcy needing to liquidate everything they can as quickly as possible to raise cash even if they know the assets are dirt cheap. Real estate also fluctuates over time with prices collapsing then recovering. As long as the portfolio you've built is constructed intelligently, and the underlying holdings are backed by real earning power and assets were acquired at reasonable prices, you will be fine in the end.

Consider the stock market. Between April 1973 and October 1974, stocks fell 48 percent; between August 1987 and December 1987, the drop was 33.5 percent; from March 2000 to October 2002, it was 49.1 percent; from October 2007 to March 2009, the decline in equity prices was a heart-pounding 56.8 percent. If you are a long-term investor with a reasonable life expectancy, you will experience these kinds of drops more than once. You may even watch your $500,000 portfolio decline to $250,000 even if it is filled with the safest, most diversified stocks and bonds available. A lot of mistakes are made, and money lost, by attempting to avoid the inevitable.

4. The Evidence Is Abundant, Overwhelming, and Crystal Clear: Most of You Will Experience Far Better Real-World Returns By Paying a Qualified Advisor to Work With You to Manage Your Financial Affairs Even If It Increases Your Expense Ratios

Before the rise of behavioral economics, it was generally assumed that most people were rational when making financial decisions. Studies produced by the academic, economic, and investment sectors over the past few decades have demonstrated how catastrophically wrong this assumption turned out to be in terms of real-world outcomes for investors. Tragically, unless a person has the knowledge, experience, interest, and temperament to ignore the market's inherent fluctuations, they tend to do extraordinarily foolish things. These mistakes include "chasing performance" (i.e., throwing money into what has recently increased in price). Another example is selling otherwise high-quality holdings at rock-bottom prices during times of economic distress (e.g., selling shares of well-run, financially sound banks when they dropped 80 percent in value a few years ago before recovering in subsequent years).