Have you heard about Ronald Read who had worked at a J.C. Penney department store as a janitor for 17 years till 1997? Well, he’s an embodiment of smart investing and frugal living. He would often eat breakfast at a local convenience store and buy blue-chip stocks and hold onto them for years. He left behind quite an estate, which he donated to charity and to his local library.
If you’re interested in investing and putting your money to work for you, there are some basics that you should know.
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Things to consider before investing
Before you embark on your investment journey, ask yourself a few questions first. Start with an overview of your current financial situation, including your income, expenses, debt, and savings. This will give you a clear picture of your financial health and help you determine how much you can afford to invest.
Also, do you have an emergency fund? This fund should ideally contain three to six months’ worth of your living expenses, and you should keep it in a safe, easily accessible account.
The next set of questions is about your investment goals. Are you investing for a down payment on a house or something grander like retirement? This will affect your investment horizon, the choice of assets, and the choice of strategies.
The point is to build a solid foundation and understand what you’re looking for. Investing is not the kind of activity you can jump straight into. There’s a lot of learning involved, and the least you can do is be clear and truthful about your financial position and goals.
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1. Invest in what you know
“Never invest in a business you cannot understand.”
Warren Buffett
It’s general advice to invest in companies and industries that you have some level of expertise or knowledge about. Whether it be from personal experience, education, or professional background, you want to have some familiarity.
For example, if you have a background in healthcare and understand the industry well, you’ll be more confident in investing in healthcare stocks or other healthcare-related assets. Similarly, let’s say you have a passion for technology and keep up with the latest trends. Then you’re better positioned to identify emerging tech companies that have the potential to outperform.
Also, it becomes more engaging and enjoyable than investing in something you know nothing about.
2. Understand your risk tolerance
Some people are comfortable with high-risk, high-reward investments. If you’re one of them, certain methods of investing may appeal to you more, like venturing into volatile stocks or cryptocurrencies. If you’re an investor who prefers lower-risk, more conservative methods, look more into fixed-income instruments like bonds or dividend-paying stocks. These types of investments may offer lower returns, but they also tend to carry lower risk.
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Your risk tolerance is affected by a variety of factors: your age, financial goals, investment experience, and personal values. Compare a young investor with a long time horizon with a retiree looking to preserve capital. Their portfolios will probably look widely different.
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3. Invest regularly
This rule is simple: invest a fixed amount of money on a regular basis, regardless of market conditions.
It’s human nature to want to buy when the market is up and sell when it’s down. But this type of behavior often leads to poor investment decisions and missed opportunities. Instead, why not take emotion out of the investment process? Just maximize your chances of benefiting from the market’s ups and downs without trying to time it.
Also, a regular or semi-regular investment schedule doesn’t let you get sidetracked by short-term market movements or the latest investment fad. This helps you build discipline and consistency in your strategy.
4. Invest for the long term
“Investing should be more like watching paint dry or watching grass grow.”
Paul Samuelson
If you’re determined to let your money work for you, you’ll have to adopt a patient mindset. And you’ll need to hold onto investments for an extended period, usually years or decades, and allow them to grow over time. But there are many benefits you can reap from this.
For one, it’s the opportunity to ride out market volatility. In most cases, the markets tend to recover and rise over time, even after experiencing downturns. In fact, historical data has shown that the longer you hold onto your investments, the more likely you are to see positive returns. It’s not a guarantee but rather something to keep in mind.
5. Keep costs low
Investing can be an expensive endeavor, and as an investor, it’s important to be aware of the costs involved to maximize your potential gains. And every dollar saved on fees and expenses is a dollar that can be reinvested.
The most common types of costs associated with investing are:
- Expense ratios: the cost of managing a fund or investment
- Market costs: transaction fees
- Custodian fees: charged by financial institutions to hold and manage your investments
- Advisory fees: charged by financial advisors for their services
- Commissions: charges for buying or selling securities
- Loads: sales charges for mutual funds
Be mindful of these investment costs and seek out lower-cost options when possible.
6. Consider tax implications
Investing isn’t just about getting a return but also about how much of that money you get to keep after taxes. One key consideration is the holding period of your investments. If you hold an investment for more than a year, you’ll generally qualify for lower long-term capital gains tax rates. But this depends on the tax laws in your country.
Another important aspect of tax-efficient investing is understanding different types of accounts. If the tax laws in your country separate taxable accounts and tax-deferred or tax-exempt accounts, you should take advantage of them. For example, investments that generate a lot of income or are taxed at higher rates are better suited for tax-deferred accounts.
7. Monitor and adjust
Think of your portfolio as a living organism that requires constant attention and care. You wouldn’t expect to plant seeds and walk away without ever checking on them, would you? Similarly, your portfolio won’t be doing well unless you regularly monitor your investments and make sure you’re on track to meet your financial goals.
Remember that the financial world is constantly evolving, and what was a good investment yesterday may not be tomorrow. So, keep an eye on your investments and make adjustments as necessary. If a top performer in its industry suddenly faces new competition, you may want to re-evaluate.
Avoiding common mistakes
In this section, let’s list some common investment mistakes and follow them up with possible solutions:
- Overreacting to fluctuations. Many investors easily panic and start selling their investments during market downturns. But this often prevents you from realizing long-term gains, which is the whole point of investing. The solution is to ride out short-term fluctuations and stay in the market.
- Focusing too much on short-term gains. There is also a temptation to chase after short-term gains rather than sticking through for long-term goals. Similarly, you should maintain a long-term perspective.
- Investing based on tips and rumors. If you hear something from friends, family, or the media and treat it as a serious tip, it quickly becomes dangerous. Do this instead: do your own research and base your decisions on solid fundamentals and analysis.
- Having a high turnover. This will only increase transaction costs and result in higher taxes. The solution would be to focus on assets with strong long-term growth potential.
- Getting attached to your investments. If you fall in love with a company you’ve invested in, you can become hesitant to sell even when it no longer makes sense from a financial perspective. Stick to your investment strategy even if it means selling a beloved asset.
Why it’s better to start early
If you’re new to investing, the best way to make your money work for you is to start small and slow. This will help to build confidence and develop good investing habits without risking too much of your capital. But time is a critical factor.
By starting early, you give yourself the opportunity to reap the possible benefits of compounding gains. In other words, you can reinvest the returns generated by your investments. This way, your investment portfolio will become a snowball rolling down a hill, getting bigger and faster as it gains momentum.
The ultimate goal of investing is to grow your capital and outpace inflation, which can be challenging but incredibly rewarding. So stay patient, disciplined, and focused on your long-term goals.
Sources:
Why Risk Tolerance is so Important for Your Financial Goals, The Motley Fool
Benefits of Holding Stocks for the Long-Term, Investopedia
Do You Pay Taxes on Investments? What You Need to Know, Intuit
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