Most people has some form of personal savings, be it a saving deposit, some stocks that they own, an endowment plan or a sum invested in a unit trust. Having some form of savings is always better than having nothing.
At the same time, it is entirely possible to greatly enhance your returns and ensure the safety of your money if you take out a little time to plan your investment strategy.
Many people get intimidated by the sheer volume and complexity of financial advice that is available. If you are new to investing, it is easy to get drawn into either of two extremes. The first is to try and understand all the financial jargon and strategies out there employed by professionals. This will leave you totally confused, and no better off then before.
The other extreme is to be turned off by having to understand so many complex jargons and strategies that you avoid attempting to understand any of the investment options that are available, and simply keep all your money in a savings deposit which pays a low interest rate.
Both of these approaches are wrong. What you need to do is to follow a few simple principles to devise an investment plan that works for you.
Set your goals
Your investment needs to have a purpose. Once you identify the reason for which you are setting money aside for, you will also arrive at the amount that you are targeting.
Your goal could be to accumulate enough funds for the downpayment of a new home. Or you may be saving for your child’s education or even your own retirement.
In each case, the process of establishing what your financial goals actually are would help you decide the approximate amount that you require to meet it and the time that you have available to achieve your goals.
Most people have multiple financial goals. For each of these, they require different sums of money at various intervals. A relatively smaller amount may be needed in six months’ time for a holiday while a larger sum would be required to pay for home renovation.
As a rule of thumb, you should put aside money that are required within a short time-frame in less risky investments and allocate money to higher-risk options when the funds are needed after several years or more.
Age of the investor
It is common knowledge that older individuals should not put their money in high-risk avenues. This is because for most older folks, the capacity to earn decreases as they become older.
Using this principle, a person who is retiring soon should shift most, if not all, of his funds to relatively risk-free investments. Unless they have lots of excess money, it does not make sense for a 70 year-old with limited resources to park their life’s savings with the stocks of a few companies.
Conversely, for a young person just starting out on a career, putting a major portion of their savings into high-risk and high-return stocks could be a good investment strategy.
When you are young, time is on your side, and you can wait several years for your investments to give you the returns you seek.
Spend time to monitor your investments
You have to allocate time to monitor your portfolio of savings. This will enable you to rebalance your portfolio once you have made your desired return. It also allows you to cut your losses early if you have made an investment mistake previously.
The amount of time that an individual can spend on tracking a portfolio of investments differs from person to person. Some people may want to give this activity just a couple of hours per month while others may be willing to devote time to it every day.
The nature of the investments you make is closely linked with the amount of time that you are willing to earmark for the purpose of supervising your portfolio.
On one extreme, there could be a day-trader in the forex market or in the stock market, who would spend at least a couple of hours every day on this speculative activity.
At the other end, there could be individuals who cannot allocate more than an hour every week. Such a person would need to invest only in relatively stable investments that are aligned with that individual’s age and risk profile.
Risk and return are directly proportional
As an investor, you need to understand the relationship between risk and return. The higher the risk in an investment, the greater is the possibility of earning more substantial returns.
Unfortunately, many people think that if they make a high-risk investment, they will definitely earn a good return. What they forget is that the probability of them losing part or all of their capital increases as well.
Each person has a different capacity to absorb losses. A working couple in their 30’s with young children and a 50-year old multimillionaire will have very different risk appetites.
The former would consider a sum of $50,000 to be a large amount. But in the case of the multimillionaire, the person could easily put it into a risky investment, if there was even a small chance of earning very high returns. The multimillionaire may even give it to someone as seed money to start a business.
Diversify your investments
This principle holds true across investors of every age profile and risk-taking capability. Putting all your eggs in one basket is simply a reflection of a poor investment strategy.
If you have $25,000 to invest in stocks, it is far better to put it in four or five companies rather than to use all the money to purchase the stock of a single company. Even better, spread the investment between companies in two or three industries. Remember, you are an investor, not an entrepreneur.
Another related strategy that you should adopt in devising your strategy is to spread out your investments over a period of time. The riskier the investment, the greater is the need to adopt this tactic.
Fees and charges for making an investment
The fees that you pay your broker or the charges that your unit trust levies can have a huge impact on your returns over a period of time. It is important that you know the amount you will be paying so that you can make an informed decision.
To put things into perspective, consider these figures. If you invest $10,000 for a period of 6 years at a rate of 6% and pay no fees, you would have a sum of $14,185 at the end of the period.
If a 2% per year fee on the original principal amount is charged, your total amount will fall to $12,653, a massive reduction.
A good rule to follow is to keep in mind that the product that is most aggressively sold by a financial intermediary is likely to have the greatest commission for the intermediary, and hence, the highest fees for you.
To Sum It Up
Many people who build up great wealth are no different from anyone else. They have assiduously followed a few basic principles regarding investing and stuck to them till they have met their financial goals.
The earlier you start investing, the greater is the time period available to grow your portfolio. The power of compounding works in your favour. But it is never too late to get started. Even small amounts invested in a planned manner can result in a sizeable fortune over a period of time.