I MAY EARN MONEY OR PRODUCTS FROM THE COMPANIES MENTIONED IN THIS POST.
I work as an investment consultant, I used to work for an asset manager, and my friends often ask me for financial advice. Unfortunately, I realised that they often ask the wrong questions. Here are seven things you must know about investing.
1) Invest, do not speculate
I cannot stress enough how important this is. In my mind the difference between investing and speculating is very clear: invest if you realistically expect a return on your investment; speculate if you “hope” (rather than expect) return on investment. I am going to stick to the financial markets in this post, but this difference applies to other types of investments (gambling = most of the time speculation; investing a private business that you’ve researched and you believe in its future = investing; investing in a business that promised you a return but is very obscure about how it will get there = speculating, if not a scam…).
If you put your money in financial markets, invest. Do not speculate.
2) Manage your risk
This is a critical concept that many people who do not have financial know-how should know. Investing is a risk-taking activity, and there are two things you should measure with these questions:
-Your ability to take risk: do you expect any large expenses, are depending on your portfolio on a daily basis, are other depending on your portfolio…
-Your willingness to take risk: how comfortable are you with buying international stocks? What about a local company that you know? Be comfortable with the level of risk you take, or it will stop you from sleeping at night.
Once you have measured your ability and willingness to take risk, put them together and eliminate the gap between them: a good rule of thumb is to go with the lower of the two. Chances are if you are willing to take too much risk compared to your ability to take risk, you will be safer investing your assets more conservatively.
Educate yourself about risk: read financial news, 101 books, podcasts and blogs. I believe financial oriented blogs are the best resource because they give your bite-size information in a language that is easier to digest than textbooks or specialised press.
That being said, you can also get help to help you manage your risk: robo-advisers and financial planners will guide you.
3) Define your goals
I have said it before, getting to financial freedom is important for many people. This is one of my goals. You should have goals too, whether you realise it or not. For instance, most people save for a combination of the following: a car, a house, college, retirement, a rainy-day fund. Setting yourself goals will allow you to see more clearly what you need to accomplish and help you define your strategy on how to get there.
4) Start early
See my post about compound interest. If there is anything you should remember from this post, it’s this: start investing as soon as you can. The effect of compound interest can make an incredibly significant difference on your finances once you are in your 40s (and even more afterwards).
5) Your allocation will depend on your age
It might seem strange, but I will try to make it easier to understand with an example. Imagine there are three asset classes you can invest in:
-cash: returns 0.5% per year, very safe
-bonds: returns 3%, between safe and risky
-stocks: returns 6% per year, risky
Here is how you should invest in your 20s: 90% in stocks, the rest in bonds.
What about in your 50s? 60% in bonds, 10% in cash, the rest in stocks.
A young person in their 20s can afford to invest in an aggressive investment that can deliver more return but will bear more risk. If the value of the risky asset depreciates by say half, this young person still has decades of investment in front of them, and because of the high return on equity, they will very likely make up for the loss. A person in their 50s is preparing to retire and cannot afford to lose half their assets a few year before retirement: the stock market might take a few years to recover, and their allocation should be safer.
6) Don’t put all your eggs in the same basket
(otherwise known as diversification in financial lingo). Financial instruments are often correlated if they are exposed to the same factors. For instance, stock prices of two carmakers will likely jump at the same time if the government announces public subsidies for people to buy more cars. It works the same way for a lot of other instruments (and not just stocks). To avoid being exposed to one particular sector, you need to diversify your portfolio. That way, when a portion of your asset suffers from an external event, the rest of your assets might increase in value of remain stable.
7) Think about fees and taxes
No matter how you choose to invest, you will be charged fees and depend on your jurisdiction and tax status; you will be charged taxes. But that does not mean you should not think about them: you should try to optimise them. ETFs and tracker funds are considerably less expensive than actively managed fund and can sometimes outperform active fund after deduction of fees.
That was my list of the seven things you must know about investing. If you like this article, please subscribe to my newsletter for exclusive articles and notifications, and visit my other posts in the links below. Thank you!