Before formulating any investing strategies, you must properly prepare yourself. All investments carry varying degree of risk. It’s important that you take certain mandatory precautions before you expose your hard-earned savings to potential money pits.
There are just too many unknowns to accurately predict whether someone will be a successful investor. With that said, there are certain steps that you can take to minimise your risks when investing for the first time.
Eliminate any outstanding debt
Being debt-free is of the utmost importance. On average, the interest payments on your debt are higher than the returns an ordinary investor can reasonably expect. As such, the return on your investments will likely be offset by any outstanding debt you may have. Similarly, if you invest while having debt, you run the risk of defaulting on your debt repayments, which can further exacerbate your debt problems.
Consolidate your savings
Do you have sufficient savings to fall back on? Before risking any of your hard-earned money, you need to make certain that you have a core of savings that will allow you to be financially afloat in the event your investment portfolio takes a large hit.
Plan for retirement
While investing can be used as one of the primary tools for building up funds for retirement, a sound investing strategy does not necessarily guarantee your future retirement security. Instead of solely relying on future investments to fund your retirement, it is vital that you start saving for your later years as early as possible. Refer to our retirement planning guide for more specific information.
Be comfortable with volatility
The stock market is heavily influenced by the whims of individuals and is constantly subject to their fleeting emotions. If you invest for a long enough period of time, your investments will invariably undergo price changes that materially affect the value of your portfolio. You must possess the mental discipline to act rationally while you are losing a lot of money, which is a lot harder than you may think. If you are unable to handle this, you will be better off allowing your money to be managed by a capable financial advisor.
Investing in the market without properly understanding the basic asset classes can be likened to buying a car on a complete whim. Without understanding the differences between your options, especially their relative performance, how could you ever hope to be happy with your purchase?
Once you understand the basic types of investments you can make, you must familiarise yourself with the term, ‘diversification.’ Diversification allows you to reduce your exposure to the inherent risks in the market, and can take on many forms.
Investing in asset classes, that are either unrelated or inversely related, allows you to spread the risk across your portfolio more effectively. Generally, when the overall value of equities fall, bonds begin to rise, and vice versa. For example, if half of your portfolio consisted of equities, and the other half bonds, and the stock market took a plunge, the increase in bonds may mitigate some your losses.
Holding equities in multiple sectors allows you to further reduce your portfolio’s exposure to risk. If you are heavily invested in one sector, and investors become bearish on that particular sector, you are likely to suffer large losses. However, if you spread your investments across unrelated sectors, you reduce the risk of one sector’s poor performance heavily affecting the overall value of your portfolio.
While investing in foreign markets can allow you to reduce the impact of isolated stock market movements on your portfolio, you must take care to choose the foreign market wisely. If you invest in undeveloped markets, you may subject yourself to a degree of volatility that could outweigh the benefits of diversification.
Portfolio Equity Diversification
You should never invest a large portion of your portfolio in one company. Instead, you should diversify your portfolio across many companies, ideally in varied sectors. Less experienced investors may want to consider investing in mutual funds or ETFs, as they often contain built-in diversification.
Once you understand the five asset classes, as well as the various diversification strategies, you are well on your way to begin planning your investment portfolio. While investing strategies and theories are outside the scope of this guide, you may find the following resources helpful in broadening your investing knowledge.
If you are interested in investing literature, Forbes has compiled a list of many seminal books on investing, which can be read here.