Once you have established your investing budget and have learned the basics, it’s time to set your investing goal. Even though all investors are trying to make money, each one comes from a diverse background and has different needs. Forming a goal helps determine the best investment vehicle to fit that particular goal. For example, when saving for retirement, a tax-deferred savings account — such as a traditional IRA — should be probably be used. Safety of capital, income and capital appreciation are some factors to consider; what is best for you will depend on your age, position in life and personal circumstances.
Determine Your Risk Tolerance
Would a small drop in your overall investment value make you weak in the knees? Before deciding on which investments are right for you, you need to know how much risk you are willing to assume. Do you love fast cars and the thrill of a risk, or do you prefer reading in your hammock while enjoying the safety of your backyard? Investments that carry more risk offer a higher potential for return. Conversely, lower risk investments generally offer a lower rate of return. In the perfect scenario, an investment portfolio that has high return with little risk is the target goal for any investor. Your risk tolerance will vary according to your age, income requirements and financial goals.
Find Your Investing Style
Now that you know your risk tolerance and goals, what is your investing style? Many first-time investors will find that their goals and risk tolerance will often not match up. For example, if you love fast cars but are looking for safety of capital, you’re better off taking a more conservative approach to investing. Conservative investors will generally invest 70-75% of their money in low-risk, fixed-income securities such as Treasury bills, with 15-20% dedicated to blue chip equities. On the other hand, very aggressive investors will generally invest 80-100% of their money in equities.
Learn the Costs
It is equally important to learn the costs of investing, as certain costs can cut into your investment returns. As a whole, passive investing strategies tend to have lower fees than active investing strategies such as trading stocks. Stock brokers typically charge commissions. For investors starting out with a smaller investment, a discount broker is probably a better choice because they charge a reduced commission. On the other hand, if you are purchasing mutual funds, keep in mind that funds charge various management fees — which is the cost of operating the fund — and some funds charge load fees.
Find a Broker or Advisor
The type of advisor that is right for you depends on the amount of time you are willing to spend on your investments and your risk tolerance. Choosing a financial advisor is a big decision. Factors to consider include their reputation and performance, how much they charge, how much they plan on communicating with you and what additional services they can offer. Those who feel uncomfortable with do-it-yourself investment accounts can still go to a full-service brokerage firm. These firms may provide more service or expertise, but they do come at a higher cost and may have a minimum asset level requirement to open an account.
Choose Investments
Now comes the fun part: choosing the investments that will become a part of your investment portfolio. If you have a conservative investment style, your portfolio should consist mainly of low-risk, income-producing securities such as treasury bonds and money market funds. For those who do not want to pick individual stocks or bonds, you may look to mutual funds or exchange traded funds (ETFs). The key concepts to emphasize here are asset allocation and diversification. In asset allocation, you are balancing risk and reward by dividing your money between the three asset classes: equities, fixed-income and cash. By diversifying among different asset classes, you avoid the issues associated with putting all of your eggs in one basket.
Keep Emotions at Bay
Don’t let fear or greed limit your returns or inflate your losses. Expect short-term fluctuations in your overall portfolio value. As a long-term investor, these short-term movements should not cause panic. Greed can lead an investor to hold on to a position too long in the hope of an even higher price – even if it falls. Fear can cause an investor to sell an investment too early, or prevent an investor from selling a loser. Successful investors remain disciplined and are not influenced by day-to-day fluctuations or outside factors. The ultimate goal of any investment is to buy low and sell high. However, most unsuccessful investors trade with emotion, unknowingly buying high and selling low. If your portfolio is keeping you awake at night, it might be best to reconsider your risk tolerance and adopt a more conservative approach.
Review and Adjust
The final step in your investing journey is reviewing your portfolio. Once you’ve established an asset-allocation strategy, you may find that your asset weightings have changed over the course of the year. Why? The market value of the various securities within your portfolio has changed. This can be modified easily through rebalancing. Individual investments within a portfolio can grow at different paces. If the stock portion does very well, it might be a good idea to reallocate the growth back into bonds. Otherwise, it may increase the overall risk of the portfolio. Continually reviewing and rebalancing your portfolio is a key to successful investing.
