A key move that helps to ensure you’re able to achieve all your financial goals, investing is the best way to grow your money. Your investment choices, however, count and in order to invest well you need to find the right assets that fit your objectives, time frame and risk tolerance.
So how can you go about selecting the right investments for you? From understanding the basic principles of investing that can help your achieve success to grasping the main differences between the various asset classes, investing can feel a lot like running a marathon. But armed with some basic knowledge and the tips below, you can greatly boost your chances of improving your investing skills.
Keep on reading to discover the key pointers you should keep in mind when choosing what to invest in.
Things to consider before picking your investments
You may be eager to get started investing, however, it’s important that you don’t throw caution to the wind and instead, take into consideration the below pointers before making any investing decisions.
Craft a personal financial roadmap
At just 11 years’ old, Warren Buffett made his first investment, buying three shares of Cities Service Preferred for just $38 per share. The stock quickly dropped to only $27, but Buffett held on until it reached $40. He sold his shares at a small profit but regretted the decision when the stock shot up to nearly $200 a share. While he later cited this experience as an early lesson in patience when it comes to investing, another lesson behind this anecdote is that you don’t need much money to get started investing.
Having said that, before you fork out your hard-earned money to invest, make sure you sit down and take an honest look at your entire financial situation. Without a plan and figuring out both your goals and risk tolerance, there is no guarantee that you will make any money from your investments.
Take into consideration your timeline
Regardless of the assets you decide to invest in, you need to commit to a period of time during which you must leave those investments untouched. Although it may be possible to generate a return in the short-term, this is less probable. In contrast, you should expect a reasonable rate of return if you have a long-term horizon, since the longer you let your investments appreciate, the more likely they are to weather the inevitable ups and downs of the market.
Once you have established your timeline, you must commit to it so that you can give your money time to grow and compound. The true magic of compounding can only take place over long periods of time. This is why people who start the investing game earlier in life can easily outperform late starters.
Evaluate your aversion to risk
As the old saying goes, the bigger the risk, the bigger the reward, yet, it’s important to also remember that the higher the climb, the harder the fall. All investments involve some degree of risk. Can you sit tight and focus on the long game, even as you’re watching your investments get a hit? If your reaction to a market downturn is to take your money and run, then you need to create a portfolio that is less volatile. While the risk-return trade off might be smaller and you may be giving up on some potential gains, it is still worth sticking to your investments.
For instance, a study by Fidelity Investments found that investors who continued to invest in stocks right through the 2008-2009 market crash ended up with account balances that were about 50% higher a mere 10 years later, when compared to those who sold out their stocks during the downturn.
How to choose what to invest in
Once you have covered the basics mentioned above, it is time to get started investing. But with myriads of asset classes available, you may be wondering how to choose what to invest in. Remember that even top investors can go from years of high performance to equally long losing streaks. While there’s no guarantee that you’ll always pick the right investments for your financial goals, what you can do is improve your chances of success through discipline, patience and following the tips below.
Choose the right asset classes
As you may have guessed, there is more to investing than just stocks. From traditional assets such as stocks, bonds, ETFs (exchange-traded funds) and funds to alternative assets like the likes of commodities, real estate, collectibles, venture capital and others, the choice abounds. However, alternative assets tend to call for specialised knowledge. Unless you know the ins and outs of the real estate market or you’re an antiques expert or a gold coins aficionado, it is best to stay clear of these types of assets.
As its name implies, asset allocation allocates a portfolio’s assets according to a number of factors, such as the investor’s goals, time horizon and risk tolerance, amongst other things. Although there is no particular formula that can be used to find the right asset allocation, it is important to understand that each asset class, be it stocks, fixed-income or cash and equivalents have different levels of risk and return, while they each behave differently over time depending on what’s happening in the markets, the economy as a whole and several other factors.
If you have decided to build a portfolio of stocks and bonds, you may then wonder how much weighing each should have in your portfolio. This will depend on several factors, but generally speaking, if your goal is higher returns and you can tolerate the risk, an allocation of mostly stocks may be the way to go, since historically, their total return has been higher than that of all other asset classes. In contrast, if temporary losses make you sweat and lose your sleep, you may want to concentrate on lower-risk options like bonds.
Opt for a mix of classes
As a 24-year-old graduate student at the University of Chicago, Harry Markowitz wrote an article on portfolio selection which, in 1990, won him the Nobel Prize. In the almost four decades it took for him to receive the award, he established portfolio theory, influenced the way academic research treated portfolio diversification and revolutionized risk assessment of financial investments, amongst other things, while he honed in on the concept of not putting your eggs in one basket.
Diversification is essential to any investor’s playbook. Simply put, diversification is the process of spreading your investments across a range of assets and types of investments. In this manner you can reduce your exposure to any one instrument in particular and if one investment fails, the other will balance things out and increase your chances of good returns.
Invest in what you know
Investing in something you don’t understand can have catastrophic results, while betting on hope is never a good strategy. Naturally, you are not expected to be an expert on each and every company or the industries they operate in. But you must be able to evaluate companies within what Warren Buffett calls the Circle of Competence. Inside this circle lies your skills and knowledge which you would have mastered throughout your life, whereas beyond the circle are the things you only partially understand. According to Buffett, what matters is not the size of the circle, but knowing its boundaries.
Conduct fundamental and technical analysis
Two major schools of thought related to investing and approaching the markets, both fundamental and technical analysis are used to research and forecast future stock prices and can ultimately help you pick investments for your portfolio.
Fundamental analysis evaluates stocks and other instruments by attempting to measure their intrinsic value. This takes place by studying a wide range of things including the overall economy and industry conditions, a company’s financial strength and even the management of individual companies. A type of analysis that fits the needs of most investors, fundamental analysis can be beneficial when trying to make good sense in the real world.
In contrast to fundamental analysis, technical analysis doesn‘t look into monetary policy or any broad economic developments, nor does it look at the company’s fundamentals. Proponents of this believe that prices follow a pattern and if they can figure that out, they can then capitalize on it with well-timed trades. Not for the faint hearted, with technical analysis an investor or trader combs through copious volumes of data in an effort to forecast the direction of stock prices. This data is mainly made up of past pricing information, as well as trading volumes, amongst other things.
Rebalance every now and again
If you had to set your initial allocation and let it be, you would eventually realise that over time your portfolio would look very different from your intended target. This usually takes place because certain asset classes tend to perform better than others during some cycles. For example, if we assume that you have a portfolio with a balance of 50% stocks and 50% bonds and you had invested €10,000 evenly between the two asset classes, it could well be the case that within five years' time, the stocks in your portfolio may have doubled in value and they are now worth €10,000, whereas your bonds may have only grown by 20%, so they are now worth €6,000. This means that your portfolio relies heavily on the success of your stocks.
Rebalancing is the process of bringing your portfolio back to its original asset allocation mix so that it does not overemphasize one or more asset categories, while doing so will help you return your portfolio to a level of risk you feel most comfortable with.
Don’t get swayed by short-term volatility
Stock markets rise and fall on a daily basis, so some form of volatility is an unavoidable part of investing, however, this shouldn’t be cause for alarm. Bear and bull markets of coincide with the economic cycle which reflects the fluctuations of the economy and for better or worse, you must experience the lows of the bear market to reach the highs of the bull. But with a diversified portfolio and knowing what to expect, you will be better positioned to handle your investment decisions through them.
Find out more about bull and bear markets and how best to invest during each one.
Looking to allocate a portion of your portfolio to stocks but you’re unsure what to watch out for? Have a look at these key steps to stock picking.
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