Our page on Understanding Investing explains that investing is putting money into a financial scheme or commercial venture in the hope of making a profit. You can invest in individual companies, friends’ ventures, property, mutual funds and much more. Each possible investment carries both a risk, and a potential reward.
There is generally a balance between risk and reward: a higher risk comes with a potentially greater reward—but also more chance that you will lose your money. A start-up is inherently riskier than an established company. However, if you are an early investor in a successful start-up, you could well make a considerable amount of money when it is floated on the stock market. This page provides some tips to help potential investors.
1. Get Professional Advice and Support for Your Investing
Overall, research shows that managed funds consistently outperform individual investors.
The best way to improve your investment performance is therefore to use professional support: a professional fund manager, and an independent financial adviser. Your independent financial adviser can help you to find the right fund manager. You may like the idea of doing it yourself, however, and there are plenty of platforms for you to use (and see our page on Online Banking and Other Financial Services for more about these). You will also learn and improve over time, as with any skill.
However, the reality is that this is not a good investment strategy if you want your investments to be successful.
A good compromise might be to work with a broker or fund manager to understand the thinking behind their investment decisions. You can then, in time, branch out on your own if you still want to do so.
2. Be Clear About Your Appetite for Risk
Everyone’s appetite for—and tolerance of risk is different.
Make sure that you understand your risk appetite before you start investing. If you have an independent financial adviser, they will probably ask you to complete a questionnaire to understand your risk profile. This will give them (and you) a good understanding of how much risk you are comfortable with taking. You can then build a portfolio of investments that fits your appetite for risk.
WARNING! Most people overestimate their tolerance of risk
You are far more likely to overestimate than underestimate your tolerance of risk. You may then find yourself starting to panic when your investments lose value.
Instead, see this as a learning point. You now know that your tolerance of risk is a bit less than you thought. Regroup, reassess and reinvest.
3. Be Clear About Your Investment Aims
There are two main aims of investing: to obtain growth over a long period, or to obtain an income.
These two require different investment strategies. For example, if you want income, you are likely to want to invest in funds and shares that pay a strong dividend each year. However, for growth purposes, you might prefer companies that do not pay much dividend, but instead reinvest in the company, seeking long-term growth. Funds are generally run for one or other purpose, and people invest accordingly. It is therefore essential to know which you want.
If you are not sure, you should probably go for growth, at least initially.
4. Check that Your Portfolio is Balanced to Manage Risk Appropriately
The way to manage risk is to spread your investments out across different levels of risk. This is the main purpose behind the development of funds: they do this for you by investing in different classes of assets.
Our page on Understanding Investment explains that there are four main classes of assets: cash, property, shares and bonds. Each of these carries a different level of risk. You can therefore tailor your portfolio to your desired level of risk by investing in different amounts of each type. However, risk is also affected by location (for example, businesses in some parts of the world are more prone to economic disruption or volatility than others), and this also needs to be taken into account.
5. Avoid Day-Trading
Day-trading is buying and selling stocks in a single day, to profit from small fluctuations in the market.
It is extremely risky.
The US Securities and Exchange Commission (SEC) warns that day traders may experience very large losses. It is also true that most people who engage in day trading lose money overall. One study found that 97% of day traders made a loss. Only 1% are estimated to make very good profits, and even that figure doesn’t seem to have much of a basis in fact.
The bottom line is that day trading is not a wise investment. Indeed, the SEC says that it should not be considered ‘investing’ at all, but ‘speculating’.
You may be interested in our guest post on avoiding beginners’ mistakes as a day trader.
6. Read Widely on Financial Issues to Broaden Your General Understanding
If you plan to invest money, it is a good idea to read widely on financial issues.
Even if you are going to employ a fund manager and an independent financial adviser, it is helpful to understand what they are talking about, and perhaps even be able to challenge them if necessary. A good place to start is with the financial pages in newspapers, but there are also plenty of blogs on investing. Look for advice, but also simply for news.
The more you understand about what is happening, the easier it will be to understand investment decisions and to make your own.
7. Avoid Following ‘Tips’
Newspapers and blog writers need to sell advertising space, so they want you to visit their site. One way to do that is to provide ‘tips’. However, here’s the thing: once they’ve told everyone, it’s hardly exclusive information. It’s therefore also not very useful, because if everyone moves to buy a particular share or fund, its price will go up—and you won’t get a bargain.
Try to avoid jumping about in response to tips or news stories. It is far better to develop a long-term investment plan and stick to it.
8. Review and reassess regularly
Your situation changes over time—and therefore so do your investment goals. Funds and fund managers also come and go. A fund that was wonderful when you invested might not look so good five years later.
Take time to review and reassess your investments regularly.
One advantage of using a financial adviser is that they will prompt you to do this. They will also provide advice about changing and updating your investments to reflect changes in your circumstances, in the market, or in the funds that you own.
9. Be Prepared to Sell Losing Stocks, and Don’t Worry About Sunk Costs
Novice investors tend to think about the money that they put into a particular investment. They want to hang onto a losing stock until it regains its value.
Fund managers do the opposite. They sell losing stocks and invest in something more profitable.
You have to be prepared to let go of losing stocks, and potentially take a loss on those, for the sake of making more money somewhere else. Forget about what you spent (the sunk cost) and think about the opportunity cost—the money you could be making by investing that money elsewhere.
10. Remember that Investing is a Long-Term Game
Finally, perhaps the most important tip is to remember that investment is a long-term game.
Don’t worry too much about short-term fluctuations in either individual funds or shares, or the market as a whole. Instead, look at the long-term picture.
Investing is certainly not a way to get rich quickly. You do hear stories about people whose investments doubled in value overnight when a start-up was floated—but remember that it was almost impossible for them to realise the value of their investment immediately. They may have become millionaires, but only on paper. However, over time a careful investment strategy is likely to pay off.