the Market Truth

Dow Jones Industrial Average (Log Scale)

The two most important things to keep in mind when investing for the long term in the stock market is the equity risk premium and the effects of inflation/taxation. By seeking the chance at higher returns offered by the stock market as compared to the risk free rate of return (a U.S. Treasury), you consequently assume a greater amount of risk. As a result, not only is there a strong chance that you will make less than the risk free rate but that you will lose money in your investment - people sometimes forget this. Second comes inflation, it's effects can not be ignored when considering any investment. Moreso affecting stocks would be taxes, however, as gains from investments (unless in a tax-exempt or deferred account such as 401k) are considered capital gains.

Ok, now I will try and tackle the big question of what to invest in. Most sensible people, although there are exceptions, will agree that when investing it is better to strive for lower risk (and consequently lower returns) for the long run. As a result, these people will target the blue chips, assuming that since these large companies have done well in the past they will continue to not only continue to rise in price but perhaps more importantly continue to pay high dividends. As we all know, however, big corporations can and do fall (see: WorldCom, Enron, etc) and consequently the current consensus on low-risk reliable return investing is the ETF or index fund. With an ETF you get the benefits of a mutual fund which invests in a variety of companies or even sectors to spread risk around as well as higher liquidity, lower costs and freedom to get your cash whenever you please, unlike a mutual fund. Personally, I find the risks associated with keeping my funds vested in any company for the long term (typically over a few months) as unbalanced to the possible returns - it is simply too difficult to have a good understanding of a company's (and especially the entire market's, in the case of an index ETF like the Qs) health nor the development of factors that may influence it's stock price.

While I'm not a strong believer in value investing, it is also unwise to purchase assets simply because they have risen in the recent past. Trying to time an entry is most likely fruitless unless you find yourself privy to insider information; you won't beat the market. As a rule of thumb, it is best to simply invest as funds become available. This can be applied to almost any asset, the fact is you will most likely lose money in the long run (or the opportunity for more money) by leaving your assets in cash rather than investing. Both fundamental and technical analysis, harolded by many to contain the holy grails of trading and investing are ironically worthless as they rely on the future being influenced by the past to forecast the behavior of assets. While this may be the case under some very specific situations, in general the market and even a particular stock is affected by entirely too many factors for the past to play any significant role in the future direction. As a result, fundamental and technical forecasting is rendered worthless, I will touch upon this in later articles.

Finally, always keep in mind that stocks (or a particular ETF) is not the end-all-be-all of investing. I suggest against trying to predict the future, instead make sure to expose your portfolio to various asset classes as well as sectors of all levels of recent performance - but this is an entirely different matter, asset allocation/diversification. Also, for one of my personal favorite books on the investment/saving psychology, check out Rich Dad, Poor Dad under the books section on the right.