Here Are 4 Critical Success Factors to Consider When Investing
6 November 2017
Most people would have some form of savings or at least a plan to save. Often, this is limited to accumulating money in your savings account or purchasing a savings plan, sometimes referred to as endowment plans, after interacting with an insurance agent.
While this is better than doing nothing, you should also consider a long-term investment plan that will improve your returns while protecting your spending power against the eroding effect of inflation.
Most people have two reactions to the word “investing”.
The first reaction is to freeze up whenever someone mentions it. Some people find it intimidating and believe that they will lose money in the stock markets. This is so especially after getting bombarded with technical jargon and reading about mis-selling and pressure tactics employed by certain financial institutions in the news.
On the other end of the spectrum, some new investors look up to the Warren Buffetts and John Templetons, and immerse themselves fully into the investing world. They strive to find out the meaning of every technical jargon, research the numerous investing strategies and strive to keep up with every single market update.
This approach is no better as it leaves you mired in too much information, making you more confused than enlightened.
What Do You Need To Know Before You Start Investing?
By setting simple goals for yourself, you can gradually build up your confidence in investing. For example, you could set aside a portion of your savings to go towards investing each month. This can be as little as $100 through a monthly investment plan that many local brokerages offer.
You also need to understand your investment objectives. If you are investing for your retirement, the way you go about can be very different from growing your money to pay for a big ticket item, such as your wedding or the downpayment for a home, a few years down the road.
Essentially, you need to know how much of your money is going towards your long-term and short-term objectives.
To shorten your learning curve, you can start your investing journey by putting your money in investments that you are familiar with. Simple investing strategies include putting your money in broad-based index funds such as the Straits Times Index (STI) Exchange Traded Fund (ETF), which tracks the top 30 Singapore listed companies, or the ABF Singapore Bond Index Fund, which tracks high quality bonds in Singapore.
You can gradually move towards stock picking or investing in more complex instruments after you have gained sufficient knowledge and confidence. When you do, focus on investments that you understand. For example, if you are someone who likes to analyse and own properties, you can invest in Real Estate Investment Trusts (REITs) or directly into the stocks of property developers in Singapore. If you are working in the finance sector, you would naturally understand the risks and bright sparks of banking stocks.
However, before moving to riskier investments, you should hone your knowledge of these four investment concepts that will be key to your success.
#1 Risk VS Return
You need to understand the relationship between risk and return. Typically, the higher the return you expect to receive on your investments, the higher the risk you are taking.
It is also important to note that you are looking at expected returns rather than guaranteed returns. There is always an element of risk that you may not achieve the returns you are looking at or even face losses.
People have varying degrees of risk appetites. This can be based on your personality or your circumstances in life. An aggressive person may be more willing to take higher risks to earn better returns while a conservative person may prefer to accept a lower return in exchange for less uncertainties.
#2 Asset Allocation
Asset allocation is the act of spreading your investments across different asset classes. This includes equity and debt, but may also encompass real estate, physical commodities like gold and alternative investments.
The main benefit of asset allocation is ensuring that your investments are not perfectly correlated to one another. This means that you do not want all your investments to move in tandem towards a particular piece of news, government policy or economy cycle.
Different asset classes are also inherently linked to different risk-return trade-offs. Equities are traditionally more volatile and therefore better deployed as a long-term investment when you have years to ride out the ups and downs of the market. Bonds are often seen as less volatile investments, making it a logical investment choice for people looking to safely grow their money.
Asset allocation alone does not diversify your risks. You could be buying bonds from a particular company and still be investing in its stock. It’s clear that by doing so, you are investing in different assets but you’re not adequately spreading your risk, as the failure of that particular company would cause you significant losses in both the value of your bond and stock.
The primary reason to diversify your investment portfolio is to limit your risk exposure. No matter what your investment objectives are, you can diversify your portfolio to lower your risks without affecting your expected returns.
One of the most common ways to explain this concept is the proverb stating “you should not put all your eggs in one basket”. By putting your money, or “eggs”, in multiple investments (“baskets”), you are able to reduce your overall portfolio risk without reducing your expected returns.
#4 Investment Horizon
It is important to know your investment horizon. This refers to when you need to cash out your investments.
Investors with longer horizons can afford to take greater risks as they are able to ride out market volatility over a long period of time. Those with shorter time horizons should take less risk to protect themselves against unexpected market movements.
Monitor Your Investments Regularly
It is important to monitor your investments periodically. This will allow you to measure how well it has performed compared to other suitable benchmarks.
Another reason you should monitor your investments is so that you can make adjustments to it. If you decide that the time is right to switch to a more conservative strategy, or a strategy that gives you passive income, you can transit to it slowly.
Do you agree that these are the four most important critical success factors when it comes to investing? Or are there other factors what should be included? Discuss your views with us on Facebook.