The Motley Fool

3 Investment Rules We Should All Live By

One of the goals for most investors is to one day enjoy financial freedom. While this is not an easy goal to attain, it is nevertheless a realistic one to aim for. Clearly, it takes time to achieve a situation where an investment portfolio will generate sufficient income through which to live. However, following these three investment rules could make it come along that little bit sooner.

Live within your means

Perhaps one of the most difficult parts of investing is generating the capital through which to invest. This is challenging because in everyone’s younger years it is difficult to look decades ahead, and so short term spending tends to take priority. However, by living within your means and saving a proportion of income each month, it is possible to build a significant portfolio in the long run.

A key reason for this is the effect of compounding on returns. Even starting just a few years younger with relatively modest capital can really pay off in the long run. And even though most people begin their careers with relatively modest salaries, even 10% of a small sum is better than nothing when it comes to generating a return.

Invest in shares

Most investors tend to people who are closing in on retirement. That’s partly because retirement is something which is difficult to contemplate until it is just around the corner. However, it may also be because shares are viewed as somewhat risky, and many individuals would rather take perceived lower risk options such as cash or property during their working lives.

However, this is not necessarily the case. Certainly, it is possible to be wiped out when buying shares, but this is relatively unusual. By focusing on diversifying between different sectors, countries and types of stocks (e.g. cyclicals and defensives) it is possible to create a lower risk portfolio. This could appeal to investors who are still some way off retirement, since it may mean that returns are smoothed out rather than being volatile.

Clearly, shares offer a level of return which few assets can match. And even stocks which fall heavily can still come back to deliver a profit if investors allow them the time to do so. As such, buying shares is a big step towards achieving financial freedom.

Being disciplined in retirement

It is all too easy to spend, spend, and spend some more in retirement. After all, a lump sum is often available which is easy to fritter away. However, in doing so an investor loses his or her financial freedom. A better idea is to create a spending strategy and stick to it through thick and thin.

A popular method is the 4% rule. This means that only 4% of a portfolio’s value is spent each year. Given that a number of indices offer between 2% and 4% yields, it is possible to generate some or all of an individual’s spending needs from dividends, leaving the portfolio intact to generate capital gains and additional returns in the long run. This means that a retiree will be able to live in a sustainable fashion and enjoy financial freedom in the long run.

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