Before moving on to the next financial area, let’s finish off with three key investing concepts.
Bull & Bear Markets
We speak of a bull market when share prices go up over a period of time, leading to more market activity and people wanting to buy more, thereby driving up the prices further. The opposite of a bull market is a bear market, during which prices generally go down, with many investors often wanting to offload their shares to avoid any further losses.
Most people join the masses and buy during a bull market and sell during a bear market, thereby either contributing to price increases or decreases. As a rule of thumb try to do the opposite: buy when everybody else is selling and sell when everybody else is buying. In that way you acquire shares at a low price and sell them at a high price, which is obviously a lot more sensible than the other way around.
Dollar cost averaging
Dollar cost averaging is the process by which the average cost of your investments goes down over time by taking advantage of price changes. This is achieved in two ways:
- When the market is up you buy less shares, thereby avoiding buying too much when they are overpriced and expensive;
- When the market is down, you buy more shares, thereby making the most of the shares being cheaper.
Obviously you don’t have time to track the market or predict what will happen with prices over time, so the way to achieve this is simple: by investing a set amount monthly. Let’s say you invest $300 per month:
- When prices are $100 per share, you buy 3 shares a month.
- When prices go up, you keep investing the same amount of $300 a month. The higher the prices, the less shares you buy, so if shares go up to $150 you end up only buying 2 shares.
- When the opposite happens and prices drop to $75 a share, you keep calm as your steady investment strategy now buys you 4 shares.
Simple yet effective.
The 4% rule
The 4% rule states that if on a yearly basis you take out 4% of your investment portfolio (i.e. sell 4% of your assets in order supplement your income or pension), you have a very high probability of keeping your portfolio alive on its own. Whilst you reduce the size of your portfolio by taking a part out, it will also continue to grow due to interest and dividend reinvestments as well as capital gains. Take out no more than 4% and your portfolio should survive.
With this information in mind you can start planning your investment strategy. If you want to supplement your income or pension by an additional $10,000 a year, then you need to have a portfolio of $250,000 (ignoring inflation for a moment). There are many online investment calculators available for you to calculate how much to invest on a yearly basis depending on how much time you have to build your portfolio.
Today’s challenge is to make a definitive decision as to whether to start investing, and if so, how much you can invest monthly. Also take the opportunity to calculate how much you should set aside yearly depending on your goals. Let us know how you’re doing with this in the Facebook Group or via Twitter or Instagram with #31DayChallengeToFE. You can find more details on these investing concepts in some of the 100 Steps to Financial Independence: Step 54: Bull and Bear Markets, Step 79: The 4% Rule and Step 96: Dollar Cost Averaging