4 tips that will make you a smarter investor

There is no perfect investor or investment strategy, but there are certainly smart ones. Different strategies will work for different people for different reasons, but there are some proven investment tips that can benefit every investor. Here are four things you can do to become a smarter investor.

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1. Use index funds

A stock index is used to group companies based on certain criteria, such as market capitalization, sector or ESG mission. An index fund is set up by different financial institutions to track a specific index. As an investor, using index funds is one of the best things you can do because it gives you instant diversification. With a single investment, you can invest in several companies simultaneously.

Take, for example, an S&P 500 fund like the Vanguard S&P 500 ETF (VOO -0.56%). You can gain exposure to 505 of the most well-known large company stocks in the market with a single investment. Although the three main sectors represented in the S&P 500 are information technology, healthcare and consumer discretionary, the index covers virtually every sector imaginable.

2. Understand the power of compounding

It’s one thing to make money on your investments; it’s something other than the money your investments are making starts making money on its own – that’s where compounding comes in. The sooner someone starts to understand the power of compound returns in investment, the more lucrative it becomes. All you need is time on your side, and capitalization will do the rest for you.

Imagine a scenario where you make a one-time investment of $10,000 in a fund that earns 10% per year over the long term. Here is roughly how this investment would accumulate after different numbers of years:

  • Value after 20 years: $67,200
  • Value after 25 years: $108,300
  • Value after 30 years: $174,500

It shows how much value can be added just with more time. With each passing year, the total increases more than the previous year because the money that brings in is greater. In the first year, you earn 10% on $10,000; in the 15th year, you earn 10% on more than $41,000; in year 29, you earn 10% on more than $158,000. The more time, the better.

3. Know the fees you pay

Although it is now common in the industry to allow free trades, there are still fees that investors should be aware of. Any fund will come with an expense ratio, an annual fee charged as a percentage of the total investment amount. For example, an expense ratio of 0.50% means you pay $5 for every $1,000 invested per year. Although the percentage differences may seem small between funds, over time they can add up and diminish your earnings.

Savvy investors should also be aware of the fees charged by their 401(k) plan. These fees can often go unnoticed, and many are surprised when they find out how much they’re paying in 401(k) fees. Part of the reason 401(k) fees get expensive is that they are multi-layered. You’ll pay administrative fees to the plan provider, fees on funds held in your 401(k), and even service fees for other features or services you may have subscribed to. Know how much your 401(k) is costing you.

4. Know that not all losses are worth the wait to recover

It is generally in your interest to be an investor who invests for the long term. However, there comes a time when you have to realize that some losses may never recover, and even if they will recover in the future, the opportunity cost may not even be worth the wait. Sometimes you’re hurting yourself more by keeping an investment than by letting it go.

Taking a loss on an investment is never the plan, but sometimes you can find a silver lining. Like the fact that you can use capital losses to offset taxes you may owe on capital gains. Up to $3,000 of your capital losses greater than your capital gains can be deducted annually. For example, if you sold shares for a profit of $3,000 and then suffered a loss of $5,000 on an investment, you could deduct $2,000. If your losses exceed the $3,000 deduction limit, you can carry the excess forward to subsequent years.

Savvy investors know when it’s time to move on.

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