Investing may seem daunting at first. However, it can also be quite rewarding when you're making the right decisions. Investing your money is an essential step toward your long-term financial wealth. And you want to make sure your investments will bring you fast-growing dividends. The main goal is to make your money work for you. However, there are certain things an investor should consider before making an investment decision to avoid potential losses.
1. Importance of financial literacy
Financial literacy is the ability to understand and apply financial skills. In today’s world, being financially educated is essential. Nowadays, people have to manage various mortgage accounts, retirement, credit score, etc. Lack of financial education can affect your life in multiple ways. Did you know discussing finances can cause anxiety for many people? So many people are scared even to face their financial situation in conversation, let alone in their daily lives. Being financially literate will improve your life in so many ways:
- Understand your earning and spending habits. When building your financial literacy, it's crucial to know your budget, see how much you make and spend, and constantly keep track of it.
- Pay off your debt and avoid acquiring one. Financial literacy can help you find the lowest rates to pay off your debt faster and educate you on how not to get into one.
- Protect yourself from bankruptcy. Being financially literate will help you manage your money and avoid bankruptcy in the future.
- Save money and invest. You're going to have a better idea of how much you should save and what amount to invest.
2. Figure out your financial goals
Before you start investing, you need to understand your priorities and financial goals. Setting your short-term and long-term financial goals is an essential step toward becoming financially secure. It's also going to help you determine where your financial situation stands. Although everyone’s investing goals are unique, the three most common investing goals are:
- Retirement planning;
- Life events such as weddings;
- Lifestyle funds or rainy days funds.
You can choose any of them and build your strategy from there. Depending on your goal, you will have a different financial roadmap. A financial roadmap is a guide to help you remember your priorities and goals.
3. Evaluate how you are with risk-taking
Investing may be risky, so you should know how comfortable you are with taking a risk before investing any amount. You can begin with the understanding that all investments carry some level of risk. Risk is any uncertainty that has the potential to affect your financial welfare. The story of risk associated with a particular type of investment correlates with how much return can be received. Meaning the riskier investment, the better may be the reward. Historically, stocks have the most annual return, and they are more dangerous than, for instance, bonds. So, whether you have a long-term financial goal and are comfortable taking a risk, investing in security assets like stocks and bonds is a good option with a potentially more significant reward.
4. Consider an appropriate mix of investments
There are so many investing options. The mix includes stocks, bonds, cash, or money securities. It is recommended not to put all of your money in one type of investment because, historically, when rewards on one kind of asset go up, another goes down. So, it is wise to diversify your portfolio as much as possible. Investing in more than one category also reduces the risk of losing your money and increases the possibility of a more significant return on investment. Since each asset has its level of risk and return, an investor should consider many different aspects, such as investment objectives, risk tolerance, available money to invest. Taking all that into account, you can create your diversified portfolio.
5. Be on your toes if investing in one individual stock
"Do not put all your eggs in one basket."- Warren Buffett
As the old adage goes, you should not put all your money in one investment. Buying individual stocks means taking more risk since they have more fluctuations in price. In addition to it, you will have to manage your portfolio yourself, following all the recent developments and anticipating the risks. This tactic tends to be time-consuming and inefficient. However, in some cases investing in individual stocks makes sense. For instance, if you already have a diversified portfolio and can afford to take a little bit of risk by investing in a particular stock.
6. Establish an emergency fund
An emergency fund is a must-have for everyone. Building an emergency fund means setting aside money for unexpected expenses, such as unemployment, unanticipated medical expenses, home, car repairs, etc. Setting aside at least six months' worth of living expenses is your financial safety net. It feels good knowing you have your safety cushion when you need it. So, where do you begin?
- Open a savings account;
- Calculate the total amount you want to save;
- Set a monthly saving goal (for example, СHF 1'500);
- Set up an automatic monthly payment.
It is also essential to distinguish what is considered an emergency. For example, paying for an unexpected medical bill can be viewed as an emergency. However, paying from an emergency fund to go to the movies is certainly not. Therefore, distinguishing between emergency and non-emergency is essential.
7. Pay off your debt
Paying off your debt before beginning to invest is crucial. Especially if it is a debt with a high-interest rate, you may have maxed out your credit card, and on top of the high interest, you will get your credit score affected. If the interest rate on your debt is 6% or higher, you should try to pay it off aggressively. In that case, you will free up more money to invest. When you look at the numbers to compare, you will see that the typical annual rate of return on your investments is around 5% (based on average annual return of SMI over the last 21 years), while APR (annual percentage rate) is, on average, 12%. Interest rates for some debts may be lower, such as mortgages and car payments, so there is no need to pay them off urgently.
8. Consider dollar-cost averaging
Dollar-cost averaging is an investment strategy involving systematic investing of equal amounts regardless of the market price of the purchased securities. It is a tool that can build savings and wealth over a long period. It is also a way for an investor to neutralize volatility in the market. Suppose you're investing in index funds. In that case, you would continually purchase a fixed dollar amount of a specific investment, regardless of the share price. It's a low-risk strategy; you don't stress out about going up and down market prices, just constantly putting in the same amount of money. This strategy works the best when done long-term.
9. Rebalance your portfolio from time to time
What does rebalancing your portfolio mean? First, it means reviewing and readjusting assets in your portfolio. It is done by selling or buying assets to reach desired portfolio composition. Your asset mix created at the beginning inevitably changes over time. And change may increase or decrease the risk of your investment portfolio. Rebalancing is essential because asset class weighting will change over time. Financial advisors recommend rebalancing your portfolio every six or twelve months to ensure it aligns with your risk profile and investment strategy. Keep in mind that even if the portfolio performed well in the past twelve months, it still makes sense to rebalance it. There is no guarantee it will do so in the future.
10. Keep away from scenarios that can lead you to lose money
Be extra careful when you are considering your investing options. Do your research, check multiple sources, hire a professional, ask questions. There are no dumb questions about investing, and your money is at stake. A good financial advisor will welcome all your questions because they know how important it is to educate the client. So what questions should you ask before investing to ensure it isn't a fraud?
- Does it match my financial goals?
- What are the fees?
- How will it make money?
These and many more questions can protect you from fraud. The more questions you ask, the better. For example, Warren Buffett's famous saying is, "Rule number one: Never lose money. Rule number two: Never forget rule number one." When making his own investing decisions, he always shows the importance of doing your research, not being frivolous about your investment. You have to set your mindset the way you don't think it's okay to lose money. It's not.
Investing always comes with benefits and downsides. And it's essential to understand both. Investing cannot be impulsive. It requires a lot of your time, work, and dedication, but it is worth it. Once you figure out your investing goals and start step-by-step moving towards them, it will get easier. You won't be intimidated by investing anymore. Investing is for everybody, and you don't need to be an expert to be successful at it.