The thought of investing would have gone through everyone’s mind at one point or another in our lives. To let some of your savings work and earn returns rather than sit in a bank account collecting close to nothing.
For various reasons, you may have opted not to pursue this path. There could be many valid reasons, perhaps, you were still in school and did not have enough money to invest or perhaps you were unsure and did not want to risk your hard earned savings.
To help you overcome the problem of getting started, we have identified 5 things you absolutely need to know before you start investing.
1. What Are You Investing For?
Many people we talk to just want to invest. They may have picked up that urge after reading some books or engaging in conversations with their friends. Because of that, they know it is important to make their money work for them.
You know what is more important than knowing investing is important? It is knowing what you are investing for.
Are you investing with the hope of being able to retire early at the age of 45 with a steady stream of passive income? Or are you investing so that you can pay for your child’s education in roughly 20 years. Other reasons for investing could include wanting to save enough to take a few years off work to pursue further education, starting a business or buying a 2nd property.
Identifying the reasons for your investment is important for you to plan the type of investments you should be making. For example, if your plan is to gain financial independence and to retire early, then you should spend as much effort as you can looking at your monthly expenses as you do to your investment portfolio, since there is no point in making great returns only to spend it on a brand new Audi.
If your plan is to pay for your children’s education in future, then we would question what you are doing investing your money in an e-commerce business that your best friend just started.
2. Risk Vs Returns
After you have identified the reason(s) for investing, you need to understand the direct relationship between risks and returns.
When you invest, you expect to generate returns. Logically we would want high returns. However, we must bear in mind that when we look for higher returns in our investments, we need to be prepared to tolerate higher risks as well.
Higher risks can take many different forms. The most common risk that people are worried about is the risk of losing money in their investments. And yes, that’s probably the biggest risk we care about when we invest.
However risks can come in other forms as well. These include liquidity risk, where you are unable to withdraw the investment you have made without incurring loses. In this aspect, even time deposits bring it with it some risks.
Those of us who invest in properties will also face interest rate risk. For example, interest rates on our home loan may increase even as rental rates remain flat.
A higher expected return will always translate into a higher risk. If the returns appear too good to be true, then you are either missing something or investing in a scam that you just don’t know about.
Do note however that a lower return does not automatically refer to taking low risks. It could simply be a case of getting into a lousy investment.
3. Passive Vs Active Investing
Most of us are not professional fund managers. We are not paid huge sums of money each month to keep up to date with the daily economics and company news. Neither are we paid to attend company briefings or analyse pages of financial reports in the night.
Bluntly put, most of us do not have an edge over these professionals.
This does not mean we should not invest on our own. Rather, we should avoid thinking that we know how to time the market, or that we know when a stock has reached its bottom or top.
To us, blindly throwing more money into a stock that has come down significantly is similar to bluffing on 7-2 off suit on a poker hand. And if you don’t understand our analogy, then you really shouldn’t be doing stock trading, or playing poker for the matter.
If there are many good investment opportunities available to you, what should you do?
A savvy investor should always aim to diversify his or her investment portfolio, regardless of how confident they are. If you genuinely like the business outlook of SingTel, StarHub and M1, why not just invest in all three companies, rather than to choose one over the other.
And if you really like both the telco and banking sector in Singapore, why not invest in DBS, UOB and OCBC as well while you are at it.
When you diversify your investments, you reduce the overall risk you face. Diversification doesn’t just refer to buying multiple stocks or stocks in multiple industries or countries. You can also diversify your holdings across different instruments. For example, if you have a total of $50,000, you may choose to spend only $20,000 on stocks while keeping the remaining amount in time deposits or retail bonds and cash.
Always remember that you are an investor, not an entrepreneur. There is no need for you to put all your eggs in one basket.
One of the fastest growing business of our generation, Facebook, took more than 8 years from the day it started to the day it had its Initial Public Offering (IPO).
If a marketing and tech company, which probably coined the phrase “virality”, took 8 years to grow, there is no reason for us to expect our investment portfolio to grow any faster.
If we want to build a retirement portfolio or a steady stream of passive income for financial independence, we should expect for this to take at least 10 – 20 years, if not more.
Overnight successes are the exceptions rather than the norm. Personal finance website Cheerful Egg made an interesting observation that Warren Buffet, despite investing since the age of 11, made 99% of his wealth after the age of 50. This simply shows that successful investing takes time.