Luckily for you, investing for ‘dummies’ in the stock market can still be a good place to put your money. There are a number of precautions that you can take to not only give your investments a very good chance at being profitable, but also protect against most or all of the downside in an economic catastrophe.  Unlike the banks and the financial firms, you:  are not subject to restrictive legislation; are not subject to the demands of your investors; are not beholden to any pre-determined assets; and are not tied into long-term contracts.

On top of having those basic advantages against large financial companies, you are also not leveraged in any way (assuming, of course, you follow some of the advice in this article).  Leverage is the number one reason for the failure of financial services companies.  Put simply, leverage is the use of borrowed money to make an investment.  Some banks were making so much use of this that they were investing thirty dollars for every dollar of real money they began with.  It’s a great strategy when you’re making money, but if you lose even a small percentage on your leveraged investments you are effectively insolvent.  This brings us to the cardinal rule of investing:

Only invest money that you can afford to lose

This is so incredibly important that it cannot be repeated enough:  Only invest money that you can afford to lose.  There are a great deal of reasons for this:

Investing entails risk, including the loss of most or all of your money.  If you invest even a penny more than you can afford, you are putting you and your family in financial danger.

Investing money you are less attached to takes a great deal of the psychological and emotional element out of investing.  Most individual investors who lose money due so because they make wild decisions based on panic or fear.  If you are risking money you can afford to lose, this becomes less of an issue.

Your investment decisions will not inordinately affect other aspects of your life.  Knowing that a downturn in the market could significantly alter your quality of life will stress you out more than you can even imagine.

Now that that’s out of the way, we can focus on some investment strategies that are easy to implement.  By following these guidelines, you will take out a great deal of the risk involved in personal investing.

Asset diversification

This means buying a mix of assets.  The particular ideal mix is different for everybody’s individual situation, but in general you want a mix close to 60% stocks, 30% bonds, and 10% metals or real estate.  Asset diversification is one of the first things that a financial planner will have you do, and it’s for good reason.  Asset classes tend not to move in concert; this means that if the stock market takes a dive, your bonds and gold will either be steady or rising.  The profits from one class of assets will cover the losses in the other class.

Diversification

This is different from asset diversification.  This means that you should buy a nice mix of stocks or bonds.  The easiest way to do this is to buy an indexed Exchange Traded Fund (ETF) that tracks a wide variety of stocks or bonds.  The rationale is similar to asset diversification:  by having a large mix of financial instruments, you cover yourself from excess risk.  It’s extremely simple to buy an ETF from your broker.  Vanguard’s “Total World” stock index trades under the ticker symbol “VT”.  Diversifying is s as simple as buying and selling VT (or a similar indexed ETF).  Buying a share of an index fund is similar to buying a small share in every company in the world.

Do your research

You may be tempted to buy individual stocks, which is perfectly acceptable once you are properly diversified.  When buying stocks, it is extremely important that you are aware of what the financial details mean.  You can get these statistics on yahoo or Google finance, or through your broker’s research tool.  Elsewhere on this site you can find in-depth explanations on the meaning of a company’s financials.

It may seem counter-intuitive, but following these simple tips will contribute a lot more to being profitable than being a financial genius or a whiz-kid trader.  These are the very fundamentals of investing, and you ignore them at your own peril.

Related posts:

1. Value Investing
2. Undervalued Stocks – A Guide
3. How to make money in the stock market