If you are investing to build up a fund for retirement, I reckon the most important thing is to watch out for downside risks. Every pound you invest at every stage in your life before retiring is really worth the many pounds that you may end up with over time.
Indeed, careful investing can be a great way to compound your money.
Buffett’s first rule for investing
But compounding stops on the money you lose, which is why well-known investor Warren Buffett said that his first rule for investing is Don’t Lose Money.
He’s not talking about fluctuations in share prices – we can’t stop that happening. But he is talking about guarding against making risky investments that could result in the permanent loss of your invested capital.
To me, that means avoiding the shares of racy companies that run businesses with a great story and ‘huge potential’ if they are not profitable already. Sometimes these stocks sound exciting and come across as offering a fast-lane to riches.
Very often, in reality, an investment in them ends up going the other way, and it’s not uncommon for shareholders to lose 50%, 90%, and even all of their money.
Neither is it wise to speculate on cryptocurrencies, commodity prices, and foreign exchange trading, in my view. Such vehicles tend towards gambling, and the road is littered with debris from previous investors that lost a lot of money trying them out.
Retirement investing at its best
Instead, I reckon retirement investing is at its best when it focuses on the shares of good-quality underlying companies. Ideally, an underlying business should be trading in a solid market niche where it enjoys some stability.
You can usually identify firms with decent economics because they’ll be earning good profit margins. On top of that, you’ll likely find a multi-year record of consistent and rising cash inflow, revenues, and earnings.
All of those attributes often lead to an attractive record when it comes to shareholder dividends, too. And looking at a company’s dividend is a great place to start your analysis. When the directors decide what to do about the dividend each year it tells us a lot about the state of the business and their view about its ongoing prospects.
I like to see a dividend that rises a little each year supported by operating cash inflow that does the same. If you can find those conditions, as well as a level of debt on the balance sheet that makes sense, or even no debt at all, you could be onto a potential winner.
The power of diversification
But don’t put all your eggs in one basket. Even a great-looking company can trip up from time to time. So, to minimise single-company risk, it’s important to diversify your investments over several underlying businesses.
You can do that by investing in a handful of top-quality companies at the same time, or perhaps by investing in one or more low-cost, index-tracker funds, such as those that follow the fortunes of the FTSE 100, FTSE 250, and other indices.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.