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Right now I want to talk about one of the most important parts of investing. It's something many investors overlook, and it costs them.
Successful investing is more than just crunching numbers and choosing the right stocks – though that's important too! – it's about managing your risk.
All investments come with risk. Even savings accounts and government bonds come with the risk that inflation will eat away at your money over time.
You see, inflation is a measure of how much more expensive everyday products are becoming. These include food, energy, housing, and transportation. The higher the inflation rate, the more money it takes to buy the necessities of living. If your savings account only pays 1% in interest and inflation is rising by 2%, then you're effectively losing money.
In other words, everything you do with your money comes with some form of risk. But managing your risk well can mean the difference between growing your wealth and losing money to inflation.
Fortunately, risk management isn't complicated. It just takes a little commitment.
In fact, the two most essential ways of managing your risk don't require any sort of financial wizardry or an MBA. You can master them right now.
First, define your goals.
Are you investing to fund your retirement? To buy a new home? Or are you simply trying to grow your net worth?
Once you have a goal in mind, it's important to make it as specific as possible so you can measure your progress. For example, if your goal is to fund your retirement, the AARP says you'll need $1.18 million to make $40,000 a year in retirement. While you'll likely adjust that number depending on your needs and expectations, that's a tangible goal you can start tracking right away.
Once you've defined your goal you'll know how much time your investments have to grow to meet your goals. That will determine what type of portfolio you'll create and what sort of investments you'll include in it.
This is essential for risk management because without a clear goal you could end up with a portfolio doesn't meet your needs or you could realize your goal is too ambitious for your risk level.
And without a specific goal you won't be able to manage your portfolio effectively.
Later in this course we'll show you how to build and manage a portfolio, but for now it's important to think about what you want your portfolio to accomplish.
Second, avoid temptation.
Having the right temperament is crucial for successful investing.
In fact, the author of the Intelligent Investor, Benjamin Graham, dedicated a big part of his treatise to investor psychology. In his words, "the investors' chief problem – and even his worst enemy – is likely to be himself."
You'll be tempted to sell when stocks are plummeting during a recession, or to buy more as stocks surge through the stratosphere. After all, why stay in stocks if they are dropping in value and everyone else is selling? And if stocks keep busting through record highs, why not get in on the action?
While these are tempting, almost intuitive decisions, they are completely wrong.
It makes more sense to buy when stocks are scraping the bottom. That's where the biggest gains come from.
It's also why legendary investor Warren Buffett says to "only buy something that you'd be perfectly happy to hold if the market shut down for 10 years."
What he means is you shouldn't overreact to the ups and downs of the market in the short-term despite the strong temptation to do just that. If you invest in a company because it will help you achieve your goals, then you shouldn't change your mind just because other people are overreacting.
But this is hard to do! Market crashes happen because investors panic and sell. Similarly, markets can form unsustainable bubbles because investors pour money into overvalued markets expecting them to rise forever. Avoiding these psychological traps will help you protect and grow your money over the long term.
And the simplest way to do that is to set a clear goal, build a portfolio to meet it, and manage it dispassionately.
This course will give you the tools to do just that. You'll learn everything from opening a brokerage account to structuring a portfolio to finding the right investments for it. But learning to manage risk is the crucial first lesson in successfully making money with stocks.