Investing 101

Investing is not saving.

Investing is setting aside money in assets to get a return or income, while saving is just setting aside money from your income. People typically save money to buy a home or a car or to meet some large expense. Investments do not provide guaranteed returns but, if correctly done, can give good returns.

Investing is riskier than saving since it involves the risk of losing the invested capital, but it will increase your income, build wealth, and secure your financial future. However, while saving is secure, the interest you earn may not be enough to cover inflation, so one would be losing money in the long run.

Risk-Reward Tradeoff

This is the most critical rule to comprehend before investing. The risk-reward tradeoff is the relationship between the return on investment and the amount of risk in that investment. The more the return on an investment, the more the underlying risk.

One needs to understand that risk is an inherent part of investing. You will have to assess the degree of risk you are willing to undertake and be content with the return that it provides. So the starting point of investing is the risk assessment, not eyeing for expected return. This would therefore mean not comparing your returns with anything or anybody else because the underlying risks are different.

Higher potential returns almost always come with higher risks. Volatile stocks can go up quickly but fall just as fast. High-risk bonds will always pay higher interest rates to attract investors. If the potential return on investment is high, you can assume that the risk is also high.

Risk Profile

The starting point of investing is to assess one’s risk tolerance level, which can be determined based on factors like time horizon, available assets, and need for income, along with a willingness to sustain market volatility and comfort level staying invested through a market decline.

Risk appetite is your unique ability to accept and tolerate the occurrence and outcomes of various risks in your investments if they happen. Simply put, your risk tolerance allows you to sleep soundly at night. Striking the right balance between your risk profile and expected reward is one of the key challenges of investing.

Asset Allocation and Diversification

Numerous asset classes are available in the market, such as stocks, mutual funds, bonds, real estate, commodities, currencies, gold, art, and even cryptos today. An ideal investment portfolio should contain multiple asset classes.

Your risk appetite and time horizon are two key factors that will influence your asset allocation. Another consideration to consider while deciding on various asset classes is their relative liquidity.

The golden rule of investment is to allocate your money into different asset classes to protect against market fluctuations which will be mostly restricted to one or two asset classes. So, if you have poor returns in one asset class, you can often make up for it in another class, or worst, it won’t affect other classes. In addition to diversification to multiple asset classes, it should also happen within each asset class, wherever possible.

Investment Strategies

While there are many investment strategies in the market, the most popular ones are income, value, and growth investing. However, none of the strategies is inherently better than the others. You can achieve your financial objectives through any investment strategy or a combination that suits your needs.

Expert Advice

Achieving the correct diversification matching one’s requirements and tracking the portfolio can be complicated and time-consuming for investors. You may take advice from experts and professionals with a long and proven track record; still, applying your mind to your investments and portfolio is paramount.

Start with simple investments while avoiding hot tips and smart trading ideas. If it sounds too good to be true, it’s not true! A conservative approach and a long-term time horizon are generally more profitable and less risky than a get-rich-quick approach.

Start Investing

The sooner one starts investing, the more secure the financial future. Investing works best when done over a more extended period. A good rule of thumb is to set aside money for investments you won’t need for the next five years. If you keep this money in a savings account, inflation will erode its value.

However, creating an emergency fund covering expenses for six to twelve months is prudent before one starts investing. Also, paying your high-interest debt like credit cards might be sensible before setting aside money for investing.

When you set out, make sure not to get intimidated by jargon like bottom fishing, alpha/beta, crypto, options, etc. While you need to know what you are doing, it is often more important to know what not to do. Stay away from investments that you do not understand or sound too good to be true. 

Happy investing!