(1) Goals and Objectives
Write down your goals and objectives, and how you hope to achieve them by investing and saving for the long, medium and short term. Let it be a road map that will guide and steer you to your destination. By investing and managing your money wisely, you can have financial security by following the plan religiously. Budget and plan the future; get rid of debt, track your income and expenses, and start saving for personal and retirement needs. Do not get into a debt trap to finance consumption or unproductive assets as the interest and principal can dent your plan.
(2) Risk Tolerance
Risk is the negative deviation from expected return, and the tradeoff is that the greater the return, the higher the risk. Risk tolerance is what an investor is prepared to undertake to accept losses without abandoning the investment plan. Zero tolerance does not sustain growth, and its value is eroded by the effects of inflation while higher growth and return can be achieved by taking greater risk. An aggressive investor will take more risk to get better returns, while a low risk conservative investor will want the original investment, even if it loses its purchasing power. A greater risk should be taken at a younger age and during the working years as income is not required until retirement. Any losses sustained can be recouped in the long run, and taking the most risk without reckless speculation can enhance your wealth.
The return is the gain or loss on an investment, based on the risk undertaken to produce income or growth or a combination of them. A growth portfolio keeps pace with inflation, and has a higher growth potential than Income funds. Younger investors need to focus on growth, and those closer to retirement may have a combination. An ideal way to boost growth is to reinvest the dividends, as this compounds the rate of return, and makes money work for you.
(4) Asset Allocation
It is an investment strategy that balances risk and reward by mixing the assets (stocks, bonds and cash) to achieve an optimal return that is based on an investor’s goals, tolerance for risk, and time frame. The rationale for this is that assets behave differently due to prevailing economic conditions, and a portfolio can be protected against significant losses, as stocks do not move up and down simultaneously. The factors that cause one sector or category to do well may have the opposite effect on another asset thus averaging the returns and reducing the risk.
Diversification is allocating and spreading investments among different classes of financial instruments than a particular asset to reduce risk and price volatility. A better outcome can be obtained by having various sectors of the industry that are not related or correlated, as the returns are averaged out with those compensating for stocks that perform poorly at certain economic cycles. An index fund is an ideal way to diversify as it has all the companies listed on the stock market, and risks associated with market cycles can be avoided.
(6) Time horizon
Stock market investments are very volatile as prices change all the time, and are not suitable for the short term as the time horizon begins when the investment portfolio is implemented and ends when the money is retired to achieve financial goals. Younger investors have a longer time frame and may take riskier and more volatile investment and ride the economic cycles for greater reward.
Invest and stick with the plan, as there will be opportunities for accumulation and building wealth when prices fall, and with interest and dividends reinvested, the growth rate is compounded. An automatic payment to a fund will help to build a reserve, and allow you to live within your means and reduce stress to accomplish whatever you want in the future.
David Luke, Financial Advisor
Phone: 021 0229 7560