With the state of complaints on cost of living, you may find this unusual, but this subject scares the average Singaporean about as much as James Wan horror films (Insidious 2 scared me too) – becoming an investor. And I want to say that it’s completely normal. Risk will put fear into anyone, especially when money is on the line.
But the reality is that investing isn’t all that scary once you have the knowledge to do it right. Thankfully, being a good investor isn’t as complicated you think. In fact, the first step towards being a successful investor involves making four important decisions:
1. Decide What Type of Investor You Want to Be
Have you ever heard of Socrates? No, Socrates isn’t anti-virus software that’s impossible to delete from your computer. He’s an ancient Greek philosopher who coined the phrase “know thyself,” which means being aware of what kind of person you are.
No, I’m not going to go all philosophical on you, but understanding yourself is an important part of investing – especially when it comes to knowing your risk tolerance.
For example, if you’re a naturally cautious, you’re more likely to take the “slow and steady” approach to investing with positive, but lower returns over time. But if you’re a daredevil who loves partaking in adventurous activities, you’ll probably take a more risky approach to investing in high risk, high return products.
Knowing your risk tolerance is an important step in deciding what kind of investor you want to be. To find out, you need to evaluate these important factors:
- Your Monthly Income: How much you make is probably the most important factor in determining what kind of investor you are. If you earn a high income, it’s easier for you to handle losses when making high-risk investment decisions. If you don’t earn a high income, your tolerance for investment losses is low because every dollar is precious.
- Your Monthly Expenses: Earning a high income doesn’t automatically mean you have a high risk tolerance. If your debts eat up much of your wages and your disposable income is low, you should stay away from high-risk investments. But if you’ve got plenty of disposable income and any potential losses wouldn’t affect your standard of living, you can maintain a higher risk tolerance.
- Your Proximity to Retirement: If you’re 20-30 years away from your retirement goals, it’s much easier take on a high risk approach, because even if you make investment mistakes along the way (everyone makes them), you’ve still got time on your side to recoup your losses. But if you’re just a few years away from retirement, it’s better to take a low-risk approach that focuses on protecting the wealth you’ve accumulated.
- Your Savings: You must have adequate savings! If you’ve got enough cash tucked away in your bank to maintain your standard of living for at least 12 months, you’re in a better position to take a high-risk approach than someone who has little or no savings. Because if you lose your income for any reason, you’ll still have enough time to get another job without having to sell your investments, some of which may be tough to unload such as property, or blocks of stock.
- Your Insurance Policies: Your life and health insurance policies also factor into your risk tolerance level. If you’re fully covered, your family will be protected if an accident causes death or disability, which makes it easier to take a high-risk approach. If you’re uninsured or underinsured, you’re only an accident away from seeing your savings and investments disappear in hospital bills, making it advisable to take a low-risk approach.
It’s true that high risk can bring about high returns. But before you go bungee jumping off a financial cliff with an elastic cord that’s fraying at the edges, evaluate whether you can handle the economic risk of the rope snapping on you.
2. Decide How You’re Going to Avoid “Investment Emotion”
The number one mistake that most investors make is that although their objective might be to “buy low and sell high”, in reality, they usually end up doing the exact opposite: It’s a fact that the biggest inflows into markets take place at or near the peak, and that the biggest outflows occur at or near the very bottom.
You might have decided in #1 that you are a “high risk” investor with the financial capacity to accept losses as part of the investment process. If, in reality, your actual reaction to seeing those losses is to panic and sell, then your financial capacity to accept losses differs from your emotional capacity to stomach them. The latter overrides the former, and that can prove expensive since short term emotion is getting in the way of your long-term financial plans.
Since no article like this can go without at least one reference to Warren Buffet, remember the following from the investment guru: “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”.
How do you deal with this?
You either reduce your risk (and accept lower returns) to avoid the worry about losses, or you deliberately avoid making trading decisions at time of market volatility, unless these fit with your longer term objectives.
If you are doing the latter it helps to have an “investment policy statement” which you pull out regularly to review your long-term objectives, and to help put such short-term gyrations into a calmer perspective.
3. Decide What Investment Goals You Want to Reach
How do you know where you’re going unless you know exactly where you are today? That’s the question that you must ask yourself when making the important decision of deciding your investment goals.
But how do you get there?
First, you’ve got to understand your current financial situation. That means going through your bank statements, tax returns, monthly bills, and investment return statements to come up with a balance sheet showing exactly how much capital you have readily available. Once you’ve got that magic number down, it’s easier to see exactly what you can afford in terms of investment products.
But there’s another important factor to this equation – age. The difference between an investor in his 20s and one in his 50s is huge in terms of risk tolerance and wealth accumulation. A younger investor has greater capacity for risk and is focused on building capital, while an older investor is putting much of his pre-retirement salary into investment products with low, but predictable returns.
Once you know exactly where you are in terms of finances and life stage, it’s easier to decide exactly where your investment goals are.
For example, if you’re an investor in your mid-20s, your investment goals might be to build enough wealth to purchase a condo and car by your late-30s, put your kids through NUS by your mid-40s, and retire by age 55.
Meanwhile, if you’re an investor in his 60s, your only investment goal at this stage would be to make sure your investments are enough to sustain you through your retirement years.
4. Decide How to Reach Your Investment Goals
After deciding on what investment goals you want to reach and how much capital you have available – you need to decide on how to reach them. Every goal needs a plan, and investments are no different. The easiest way to do this is to establish an investment plan, which gives you insight into what kind of investment portfolio you need to achieve your goals.
No matter your age or the size of your portfolio, you should draw up an investment policy statement to sum up your investment goals. Depending on your investment experience, you can either draw one up yourself or have a financial advisor assist you.
It’s not a very hard document to create – all you need to do is establish the following:
- Your Short-term Goals: What you plan to pledge annually (ex. $30,000 of your salary & bonus) towards your investment goals.
- Your Medium-term Goals: How much wealth you plan to generate from your portfolio to make major purchases (ex. having $150,000+ to fund your children’s university tuition & fees).
- Your Long-term Goals: What you plan to pledge annually (ex. $100,000 of your salary & bonus) in your “peak” income years to fund your retirement goal (ex. $2.5 Million).
- What You Need to Do: You need to figure out how much of a return your portfolio must generate (ex. 8.5% p.a.) in order to reach your investment goals.
- Performance Evaluation: You make a commitment to evaluating your portfolio’s performance annually to see if you’re on the right track or if your portfolio needs some “rebalancing.”
Figuring out what mix of investment products will bring you the results you need to reach your investment goals is important. If you have a diversified portfolio but some of your investment products are underperforming and bringing down your returns, you’ll need to make adjustments.
This is where keeping track of market changes can come in handy. But unless you’ve got the time on your hands to check the markets daily, it’s probably easier to have a third party advise you on products that’ll keep on you on the right track.
This article was done with expertise provided by Javelin Wealth Management. Javelin provides wealth management, global asset management and private banking services that are impartial and fully independent of financial product providers. You can connect with them on Facebook and gain investing insights from their blog.
What are some key decisions you feel need to be made when you start investing? Have you had a negative experience doing/not doing any one of these things? Share your stories with us here!
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