You have opened your investment account and are ready to get started investing. Hold your horses! There are three important things to do before you invest….
Congratulations on your decision to take greater control of your financial destiny. Having opened your FlowBank investment account,the next step is to understand how best to use it.
The goal is to invest in a way that matches your circumstances.
People invest for different reasons, start investing at different times in their life and your personality will suit certain types of investments. All these factors should be considered to give you the best chance at investing success.
We’ve boiled the ‘before investing’ preparation down to three things. You should ask yourself these questions and invest according to your answers...
1. How long will you be investing for?
Take this moment to think about:
- A) How much will you invest? AND
- B) For how many years?
The answers here don’t need to be exact. You don’t need to know the exact date of retirement or the precise amount of money you will be investing for your entire life. An approximate number of years and your best guess at the amount of funds you will be contributing to your investment account is enough.
The purpose is to know your Investing Time Horizon and from there you will know where you fall within your Investment Lifecycle.
Define investing lifecycle:
The idea is that when you are investing near the start of your working life, you can take more risk and as a result you will choose a ‘riskier asset mix’. When investing closer to retirement, it’s in your interest to take less risk and choose a ‘safer asset mix’.
This typically sees portfolios that are heavily concentrated in stocks at the beginning of a working life, which gradually shift holdings to bonds as retirement nears, leaving a heavy bond concentration by the end.
Source: Pintererst.com / MarketExpress
2. What will you do with the money you earn?
Of course we all need money, but what exactly will you use the money you earn from investing for? What we are talking about here is knowing your financial goals and how investing can help you reach them.
One of the first principles of investing is not to invest money that you need for essential goods and services i.e. food and shelter. We can therefore assume that your investment returns aren’t going towards everyday essentials - but they might still be going towards something important like a car or school fees. Or the money you earn might be intended for broader, non-specific goals like financial independence or for retirement.
We can simplify the purposes of your investing into three categories:
Big purchases 🛥️
When a big purchase is one of your financial goals, the best approach is to use investing as a way to reduce the time you need to wait to make the purchase, but without taking any big risks that might mean the purchase gets delayed. Typical examples include a car, house, college tuition or perhaps a boat.
The safest choices here would be a savings account or a money market account, while stable investments with some extra risk include government or corporate bonds. As long as the entity issuing the bond stays in business, you will receive your principal (the amount you invested) back. The rule of thumb is that the higher the coupon (interest payment) you received on your bond, the greater the risk that the entity issuing the bond will default and you could lose your investment. Stock market investments are generally not advisable for big purchases because your principal is at risk.
Financial independence 💸
Financial independence (or financial freedom) is when you are not wholly reliant on a job for financial stability because you are wealthy enough and have other sources of income. How to invest in shares when looking for financial independence is usually a two-pronged approach.
- Capital appreciation = growing your wealth
- Income = receiving regular payments from your investments
Any investment that gains in value will add to your investment capital and therefore grow your wealth. The two traditional sources of income when ‘income investing’ are coupon payments on bonds or dividend payments on stocks. Newer, less proven income-earning investments include things like staking cryptocurrencies.
Saving for your retirement means deferring the benefits of having the money to use now in order to use it when you are older. Long term investing has been shown to historically provide a greater risk-adjusted return, meaning you should have more for your retirement. The generally understood approach to long-term investing is through a diversified portfolio. That means investing in different types of stocks, bonds and if you like, other assets like cryptocurrencies or precious metals.
Once you have identified all your financial goals, you need to allocate some money to each goal. We can call this financial goal prioritization. The more money you allocate to any one goal the quicker you are likely to reach that goal relative to the others.
What kind of investor will you be?
A lot of the understanding about what kind of investor you are will simply come from your experiences investing and might well change over time. But taking some time to think about your risk tolerance before you invest is beneficial. Are you the kind of person that will be pulling your hair out if your investment falls in value by 20% or would you be cool as a cucumber if your assets were down 50%?
It’s a matter of being realistic about your expectations. When investing, to give yourself the possibility of bigger returns, you must be prepared to weather bigger drawdowns to get there. If you are only willing to accept small losses, this limits your potential gains.
We can define two types of people in markets - investors and traders. In fact, many people like a little of both investing and trading. One approach is to divide your available funds into two camps:
- Long-term portfolio - This is where most of your money should go and is what will likely contribute the most to your financial goals and get you to retirement.
- Speculative capital - When speculating you have to be prepared to lose all of your investment, which enables high risk approaches that if they work can add to your wealth and/or help you reach financial independence and retire earlier.