Everyone loves the idea of hitting a home run as an investor – buying the next Apple (APPL) when it’s at $10 a share and watching it climb to $100, then $200, then split, then climb to $300, $400, $500, etc. That $10 investment can quickly become worth hundreds or even thousands of dollars. Unfortunately, for every home run you hit, you are just as likely to strike out. That is one of the inherent risks with investing. There are times when you can win big, and there are times when you can lose big.
But there are things you can do to mitigate your overall risk. For example, you can thoroughly research your investments. That won’t remove all of the risk, but it may help you reduce the number of clunkers in your portfolio. The other thing you can do is limit your exposure. And that is one of the greatest things you can do to ensure you don’t risk your retirement fund.
Playing with Mad Money – the 10% Rule for Investing
If you are the type of investor who wants to have a little fun and play your hunches, then don’t deny yourself the pleasure and the opportunity to make a nice return on your investment. But do it responsibly. Many studies have shown that a balance of index funds that mirror the major stock market indexes outperforms managed mutual funds over time. And of you go back and look at the greatest investors of all time, you will find that only a handful have been able to beat the markets for any sustainable measure. I know my investing skills aren’t as good as Wareen Buffet’s!
But even though I’m not Warren Buffet, I still want to try my hand at investing outside of the traditional index funds. For example, I would like to invest in day trading and Foreign Exchange (currency trading). I even opened a free demo account to learn more about Forex trading.
So if you feel like having fun or taking some risks with your investments, then consider maintaining a portfolio that is a balance of low cost mutual funds, bonds, and other “boring” investments that historically perform fairly well and are relatively hands off. But feel free to set aside around 10% of your portfolio as “Mad Money.” This is money you can use for whatever investments you feel like. The goal, is to limit your exposure to excessive risk and hurting your long term investment prospects. If you hit an investment home run, then your portfolio will grow and you can take some money off the table and place it in relatively safer investments. If you strike out on your investment, then you won’t lose too large a portion of your portfolio and you will be able to recover more easily than you would if you had staked a larger percentage of your portfolio.
It’s true that you may not earn as much money this way, but it is also true that you won’t lose as much either. And here is the kicker – you can use the 10% rule as a starting point. If you find that your Mad Money investments are paying off at a good clip, then you can consider letting the money ride in other investments, or adding a larger portion of your investments to your Mad Money portfolio. On the flip side, you might want to reconsider how much money you keep in your Mad Money section of your portfolio if you are consistently losing money on your investments.
