Here’s your step-by-step guide for how to become a stock market millionaire. If you can follow them I can virtually guarantee you will become a stock market millionaire!
The original article has been edited here for length (…) and clarity ([ ])[In How To Become A Stock Market Millionaire – Part 1: (The Plan) the author put forth 6 questions to ask yourself when putting together your investment plan and provided answers for each. Part 2 covers Step #2 through Step #4 – How Much Do You Need To Invest In the Stock Market Each Month To Become A Millionaire? This article covers Steps 5 through Step #7.]
Step #5: Diversification
Risk and reward are related when it comes to investing. The higher return you want to achieve, the more risk you are going to have to assume. It’s the nature of the beast. By diversifying your investments, you take away some of the risk and still earn a good return.
Here is how diversification works.
- Stocks tend to earn a higher annual return than bonds and are also more volatile. What this means is that stock prices tend to rise and fall quicker and in larger amounts than bond prices do.
If you invested in just stocks, you could earn as much as 51% in one year or lose as much as 37% in one year. With bonds, you could earn as much as 17% in one year or lose as much as 11% in one year. Most investors wouldn’t like it if they had to choose between these two. This is where diversification comes into play. If you were to create a portfolio of 50% stocks and 50% bonds, your potential one year gain drops to 32% while your potential loss drops to a loss of 17%. The numbers get even better when we extend the time horizon out to 20 years.
Of course, diversification doesn’t stop there. There are all sorts of stocks you can invest in. Small cap, large cap, growth or value stocks, domestic or international, etc. For bonds, you can invest in long-term or short-term bonds, government or corporate bonds, or even junk bonds. All this diversification has an impact on your returns. The goal of diversification is to allow you to earn the highest return with the least amount of risk. Realize that there are limits to diversification. You can get to a point where you are too diversified. Plus, you can’t diversify away 100% of the risk in the stock market. There will always be risk present.
When it comes to diversification, I go into great detail showing you the importance and impact diversifying your investments has in this post. I encourage you to read it so you can understand the power of getting the right mix of investments. Doing so will give you the most return for the least amount of risk but the bigger question is if you are already investing, how do you know if you are diversified right now and how do you go about making some changes to help you get to an ideal mix? You have two options: an automated one and a manual one. Let’s look at the automated one first.
- Automated Option: Personal Capital. You create a free account and link up your investment accounts. You will get a chart that shows your current asset allocation. In just a few minutes you will know what moves you have to make to become diversified. In addition, Personal Capital offers many other great benefits too, like fee analysis and a retirement planner all for free. You can learn more here.
- Manual Option: When it comes to a manual approach, your best option is an excel spreadsheet. You can create your own from scratch or use this one that I created. You could even just use mine as a template and edit it to make it your own as well. The benefit of going this route is having complete control over it, so you can make it exactly how you want it. The downside of course is it requires your time to update it.
Step #6: Don’t Chase Returns. Stay Invested.
This may be Step #6 but it is important. Chasing returns doesn’t work. When you chase returns, you cost yourself money through commissions and trading fees. At the end of the day, you end up in a worse position than you would be in had you just stayed invested. This is why the average investor only earns a 2% return…slow and steady always wins the race when it comes to investing.
With that said, I know it can be hard to stay invested when it seems as though the sky is falling. Especially when the media over-hypes the situation and makes it seem as though the world is coming to an end. You have to do your best to keep your emotions in check and tune out the “noise” as I call it. Turn off the television, don’t read the stories in the newspapers, magazines or online. Remember that Wall Street makes money by making you trade. The more you trade, the more money they make. Fear and greed are the two most dangerous things to an investor. You have to learn how to manage these if you want to be a stock market millionaire.
When you are feeling most worried, refer to your plan you created in Step #1. Review why you are investing the way you are and what your goal is. For most people, it is a long-term goal, so don’t get upset over things happening in the short-term…
Step #7: Track Your Progress
Unless you track your progress, you will never know if you are on track for meeting your long-term goals.
- Over time as the market moves, you might see that you are investing in more stocks than bonds. This means you are taking on more risk than you are comfortable with. By tracking your investments, you can correct this so that you stay on track.
- Likewise, maybe you now have more bonds than you planned on holding. This too can be a problem since bonds tend to have a lower rate of return than stocks. If you are investing too much in bonds, you run the risk of not earning the return you need to meet your goal.
To balance your holdings at the correct allocation, you will need to rebalance. This means selling holdings that have grown in value and buying those that have decreased in value. By rebalancing, you are guaranteeing that you buy low and sell high. You take the emotion out of investing and this is a major factor in your success with investing. Here is a quick example of rebalancing. Let’s say your ideal portfolio is 60% stocks and 40% bonds. At the end of the year you see you have 70% stocks and 30% bonds. You would sell off 10% of your stock holdings and use the proceeds to buy more bonds.
Now, when it comes to your retirement accounts, you can buy and sell without worry. There are no tax consequences from placing trades within these accounts but things get tricky in taxable accounts since you have to pay taxes on any gains you realize when you sell.
Here are the guidelines I use to rebalance:
- I review my holdings twice a year, usually at the end of June and the end of December
- I look for holdings out of balance by 5% or more. This means if my 60/40 portfolio is 62/38, I don’t bother rebalancing
- For my retirement accounts, I buy and sell without question as taxes don’t factor in
- For my taxable accounts the process is a little different. I skip the buying and selling and add new money to the assets that I need a higher proportion of so, if my 60/40 portfolio was 70% stocks, 30% bonds, all new money I invest would go towards bonds. This is until I got my portfolio back to 60/40.
Finally, as time goes on, you may realize that you need more or less money that you originally calculated. As a result of tracking your investments, you can make any necessary changes to your investment plan.
If you feel overwhelmed, but want to start investing, I encourage you to look at Betterment. It is the easiest way to get started in the stock market and we all know getting started is the key…Just take 10 minutes, pick a goal and monthly savings amount. That’s it. They will do everything else for you.
If you that want more detail on these steps, along with a few extra points, be sure to check out my eBook. The title is 7 Investing Steps That Will Make You Wealthy.
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Becoming a stock market millionaire is much easier than you think because if you take about an hour or two of your time now to create an investment strategy, you are 95% of the way to becoming a stock market millionaire. So what exactly do you need to know to become a stock market millionaire? I’ve outlined all the steps below to help you build your wealth in the stock market.
2. How Much Do You Need To Invest In the Stock Market Each Month To Become A Millionaire?
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