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Investing is one of the most effective ways of increasing wealth over the long term. It involves carefully selecting assets with the aim of growing your money to reach your investment goals. Contributing to financial security and providing more flexible lifestyle choices, investing is an important discipline that should be started as early as possible.
In the current inflationary environment, investing has become even more important. Many workers are set to retire on lower incomes than those of previous generations and the default investment alternative of keeping money in the bank risks eroding the value of cash savings.
Each one of us will have different circumstances to consider, such as age, level of income and retirement plans, so investment planning will vary. A number of factors need to be considered:
While investors have varied aims, there are questions they will need to answer before laying the foundations for their portfolio. These include deciding the investment time horizon and the level of portfolio risk which can, and should, be adapted as circumstances alter. All investors should have a strategy to help them deal with changes in their personal circumstances or in the financial markets.
Within a portfolio, equities, bonds, alternatives and cash (known as ‘asset classes’) all provide distinctive characteristics. Equities typically provide the growth component, bonds offer a regular income (called ‘yield’) while alternatives provide a further level of diversification. Cash, considered the most liquid asset because it can be easily turned into other assets, is quickly accessible and low risk. The proportion that should be invested in each asset class will depend on an investor’s goals.
Investors should not necessarily be concerned just because the value of their portfolio falls, nor should they become complacent when it is performing well. A portfolio is likely to benefit from regular monitoring and maintenance, especially as financial markets are constantly adjusting to new variables. This means the assumptions behind investment decisions, as well as their ‘fair value’ assumptions, can change.
Investing and trading are different approaches to the financial markets. Investing employs a fundamentals approach, the value of what is bought and held being key considerations. In contrast, traders generally hope to maximise returns by exploiting moves in financial markets and instruments. Investment fundamentals are usually less important for traders but therefore trading is considered much riskier than investing.
Setting financial goals for investors allows them to focus on decisions that will contribute to their overall objectives, rather than monitoring the outcomes for a range of individual investments. Just like goal setting in life, it can help individuals focus their behaviour and remain motivated.
Devising a plan encourages investors to formulate long term and short term goals. These should seek to maximise risk adjusted returns, but ensure enough flexibility to take account of market surprises and potential volatility.
This is the financial equivalent of “don’t put all your eggs in one basket”. Portfolio exposure to a range of assets and regions will supply differing investment characteristics, helping to minimise an investor’s overall investment risk.
Compounding, which is the effect of earning interest on interest over time, can have a significant positive effect on investment returns. That’s perhaps why Albert Einstein is said to have described compound interest as ‘the most powerful force in the Universe’.
Financial markets continue to throw up opportunities to make spectacular investment returns, but many of these will prove to be speculative bubbles, when an asset’s price greatly exceeds its fundamental value. An asset bubble will inevitably burst, leading to losses. In contrast, sensible investing, which means holding a well diversified portfolio for the long term, could be viewed as quite boring by comparison, but is likely to deliver superior returns.
Regular savings are the key to building up your portfolio. Rather than thinking thousands of dollars are needed, you can start investing from as little as $50 a month. Setting money aside to fund an investment portfolio is a good discipline and puts you in a much stronger financial position later on.
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