To start, there are no investment hacks and shortcuts. Investing requires time, research, and maintenance. Effort? Depends on the instrument. Stocks, for instance, would need more vigilance than bonds, which is mostly a ‘buy and wait for maturity’ affair. Overall, however, there are no instafix to get you high investment returns.
For beginners and those who want to refresh the main principles of investing, we’ve collected 8 crucial tenets.
1. Know that investing is a commitment
Investing can be compared to quality relationships. Both require patience and its close kin, time. There are more investment options available than ever on the market, with new ones like cryptocurrencies and P2P lending entering the mainstream. But before you choose “the one”, you must first determine your investment profile. Then, you need to mull over the pros and cons of various instruments before selecting those that best fit your purposes.
Time also applies to the investments themselves. Some investments allow you to cash out by a relatively quick maturity date. Others take longer. It also pays to take time and review your investments regularly. Depending on how the markets have moved, you may have to rebalance your investment portfolio to fit your personal risk tolerance.
2. Invest when you have enough savings
Everyone has a benchmark for how much savings is “enough”. But it’s essential to have several months’ worth of monthly expenses before you invest your money. Three months’ worth is a good minimum amount, six months’ worth is safer.
If your savings account is stable, you have something to turn back to if you have an emergency and need funds immediately. When all your money is tied up in investments during unexpected times, you may have to withdraw funds when the markets aren’t optimum or when your investments haven’t reached maturity – exposing you to hefty penalty fees.
3. Watch the inflation rate
The interest we get on our savings is insignificant and when you factor in banks’ admin fees, our savings usually stay flat over time. What doesn’t stay flat, unfortunately, is the price of goods thanks to inflation.
Inflation is why we invest; we want to stabilize our purchasing power in the long term. To do so, our investments must beat the national inflation rate. To solve this, balance an investment portfolio that delivers overall returns above the inflation rate.
4. Know your personal risk tolerance
Thereby, know the risk and return principle, which declares that the higher the potential returns, the higher the risk – and vice versa. Because of the risk and return principle, everyone’s investment portfolio will look different as every investor balances risk and reward according to his personal risk tolerance and future goals.
Aggressive investors will aim for instruments with the highest returns, no matter how risky. Their portfolio can consist of 80-90% high-risk instruments. Meanwhile, investors with a low stomach for risk will veer towards safer products.
Age is often, but not always, a factor in determining risk tolerance. Rationally speaking, someone young and healthy, with enough savings and a long period of productivity ahead of him can afford to take more risks.
The idea of establishing your personal risk profile is to support you in building your perfect portfolio – one that reflects your personal preferences.
5. Remember the risk and return principle: anyone promising extremely high returns either requires you to take an equally extreme risk or is selling an investment fraud
Certain instruments can be stable while offering higher returns relative to other instruments, but there is no magic instrument with high profit and no risk. It simply does not exist. Be instantly wary of suspicious offers. Investment scams tend to have several things in common: high and unsustainable returns (think monthly returns above 10%), lack of transparency, general product claims (gold, foreign exchange, etc), and no operational license.
6. Diversify, diversify, diversify
How do you mitigate risk? You diversify your investments. Diversification means allocating your funds among a variety of investments. The more diversified your portfolio, the more protected you are. Even if an investment fails, your overall returns stay positive.
Diversification is how you build your unique investment portfolio. Remember personal risk profile? Maybe you are risk-averse. You may want to compile a portfolio of 70% bonds and fixed deposits, 10% in cash and equivalents, and 20% in stocks. If I’m risk-averse, why not spend 100% of my funds on fixed deposits, you ask? Even “safe” instruments have risks. What happens when fixed deposit interests fall? Your portfolio value will be diminished. Spreading your investment across various assets will prevent this problem.
7. Reinvestment is essential
When your investments generate earnings, you have several options. You can withdraw and cash out. But if you want long-term benefits, you should reinvest those earnings so they generate more earnings.
Say you invest SGD 10,000 into bonds with 7% annual interest. After a year, you have earned SGD 700 in interest. You decide to reinvest the total SGD 10,700 into the same bonds in year 2. SGD 10,700 now reaps SGD 749 in interest earnings rather than SGD 700 and you didn’t do anything. Over time, you would double your starting principal or more. The key is in diligence and frequency.
8. Invest early because time matters
The reinvestment principle especially shines when you start investing early. Let’s say person A invests in an instrument with 5-6% annual interest at age 25 and reinvests every year. Then there’s person B who does exactly the same with the same initial amount starting age 35. Various graphs show that when they are both 60, person A would have nearly double the money of person B.
Remember: start early, commit over the long term, have enough savings, know your risk profile, be wary of suspicious offers, diversify to build an optimum portfolio, and reinvest your earnings.