Are terms like ROI, diversification, cap rates, risk analysis, puts & call confusing you? If you are seeking to build your wealth for retirement or to achieve life goals, you need an investment plan. My guide to basic investment fundamentals is simple to understand. It is always best to start young saving and investing but it’s never, ever too late to start.
Investment Basics
Investments are both a hedge against insecurities of the future from inflation and for increased needs for money such as for retirement. Critical to investing is the power of compounding. This is what makes investing attractive. Your future wealth is decided largely by the prudent investment plans you undertake now. Investments always comes with an element of risk. It is for you to weigh the level of risk with possible rewards. Understanding risk is the cornerstone of investment fundamentals.
Diversification is the key to good investment management. Spreading your assets and investments across various types of investment spreads your risk. You never want to put too much money into one category – such as all your money in one stock. Spreading you investments across stocks, bonds, real estate and other categories better insures that if one stock or investment category goes south, it will be minimized by other categories that are doing better.
Risk is about your comfort level. If you are young, you may be willing to take much larger risks, and potentially larger rewards, than if you are nearing retirement when you don’t want to risk losing the value of your portfolio.
Investments such as treasury bills, CD’s and bank deposits earn a fixed interest; and they are low risk. Stocks and mutual funds promise more growth potential. When they do well, you stand to gain because you earn money on the money your investment makes. Investment in property can bring you handsome returns but over a period of time. Those willing to take greater risks use leverage. That is, they use the banks money to make money. Borrowing to buy stocks, or borrowing to buy an investment property is riskier but gives you the potential to earn much more. Diversifying investments ensures that you don’t lose everything if a particular investment doesn’t work out well.
Funds: Decide the amount that you can set aside for investment. With right planning, you should be able to set aside and build up an investment fund. Ensure that you have built sufficient cash reserve to meet short-term emergencies. Six months of salary put away in a low-risk savings account is a good place to start. Plan your expenditures so as to redirect funds for investment. Put away a percentage of your pay increase to long-term savings investment.
Plan: Take a broader perspective when planning your finances. Chalk out your financial goals such as a child’s education, retirement or buying a home. Analyze your current situation and determine your needs.
Knowledge: You should consider taking the guidance of an investment adviser. An adviser can help in tailoring your investment to suit your requirements. This would work well for those strapped for time and those who are not well-versed with financial planning.
Time: Investing in stocks and bonds is not everyone’s cup of tea – nor do you have the time to keep up on when to buy and sell. If you buy rental property, it takes time and effort to collect rents, handle complaints, fix problems, etc. Maybe REITs, which are like stocks in real estate, is a better alternative than owning property outright. Be realistic about the time you can put into managing your investments.
Expectations: Be realistic and reasonable about expectations on investments. While some may far surpass your expectations, sometimes investments may not pay off as well as they promised. Plan your tax liabilities too when overseeing your investment plans. Consider capital gains that may come into effect.
Preparation: Before placing your money towards an investment, weigh the cost of the investment. What are the broker and transaction fees if you are buying stocks or bonds. If buying investment property, carefully detail out all expenses and you will need to project them into the future.
The best advice is to start small and learn. As you gain confidence in yourself, it is easy to expand your portfolio.
As a serial entrepreneur and active financial investor, Howard Debs offers guidance on building your wealth. More resources and advice from Howard for both novices and experienced investors at Achieve Wealth 101
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