Would you like to break the chains of a 9-5, have quiet post-work years, or travel around the world?
Well, achieving those goals and attaining peace of mind can be done through a powerful tool that many people use to realise their dream life: investing.
By allocating funds, you grow your money and achieve your financial goals, no matter if it’s for retirement, buying a house, or starting a business.
While the allure of quick gains may tempt you, planting the seeds for growth requires a different approach: patience and long-term planning.
Investing is a journey, not a sprint.
Understanding this from the outset helps you make decisions that are sustainable and rewarding in the long run. However, time is not the only aspect you must consider. Deploying capital also comes with risks and challenges that you need to be aware of and prepared for.
Today, we cover the basics of investing, how it works, why you should do it, as well as common mistakes beginners commit and how to avoid them.
Without further ado, let’s get started.
“An investment in knowledge pays the best interest.” Benjamin Franklin.
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Do’s of Investing
Before putting your money into any asset, consider these recommendations:
Research
Whether you mean to diversify your portfolio in stocks, bonds, mutual funds, or real estate, understand the mechanism behind it, the risks and returns, and how it fits into your financial plan.
Of course, you should not invest in hype, emotions, or proposals from others without verifying their credibility and record. Rather, rely on facts, data, and analysis from reputable sources, such as official statistics, economic publications, specialised sites, podcasts, books, and experts.
“Never invest in a business you cannot understand.” Warren Buffett.
Doing your homework will help you avoid scams, frauds, and losses and make more informed and rational investment decisions.
These are websites you can visit to learn more about legitimate investments:
- Morningstar: A leading provider of independent research, ratings, and tools for individual and institutional investors.
- Investopedia: An online resource for diving into investing, finance, and economics, with articles, videos, courses, quizzes, and calculators.
- The Motley Fool: This popular website offers stock picks, advice, analysis, and reports for traders of all levels and styles.
- Yahoo Finance: Useful platform that provides financial information, posts, charts, quotes, and instruments for market movers.
- MarketWatch: An internet site that covers breaking economy news, trading updates, reviews, and commentary for opportunity hunters and consumers.
With respect to official UK and US government websites offering insights on investing, stock statistics, and the business sphere, we have:
- US Bureau of Economic Analysis (BEA)
- Federal Reserve Board
- Treasury Investor Data | Department of the Treasury
- Investor.gov
- Office for National Statistics
- Bank of England – Statistics
- Trade and Investment Core Statistics Book
- UK Sector Accounts – Office for National Statistics
While any of those officials and professional websites provide valuable information, always consult with a qualified financial advisor before making any choice.
Continuous Learning
In the ever-evolving landscape of investment, ongoing education is a necessity.
As markets fluctuate and new trends emerge, the most successful investors are those who remain students in the field, eager to absorb fresh information and insights.
This commitment to lifelong upskilling enables you to adapt your strategies to changing market conditions, spot emerging opportunities, and avoid potential pitfalls.
Make education a cornerstone of your investment approach through regular reading of financial news, attending workshops and seminars, or engaging with a community of like-minded investors.
Remember, the economic world does not stand still, and neither should your knowledge.
Diversify Portfolio and Allocate Funds
This is another key principle that helps you mitigate risks and maximise returns.
Diversification means spreading your wealth across different types of assets, sectors, industries, countries, and strategies so that you are not exposed to the same uncertainty factors and can benefit from the performance of various markets.
Allocation, on the other hand, is deciding how much money you want to invest in each asset class, such as stocks, bonds, cash, or alternatives, based on your risk appetite, time horizon, and objectives.
The benefits of diversification and allocation are:
- Reduce the impact, volatility, and market fluctuations in your portfolio, as different assets tend to move in opposite directions at distinct periods.
For instance, when stocks are down, bonds may be up, and vice versa, providing a cushion for your securities collection.
- Take advantage of the opportunities and trends in various areas, industries, regions, and niches, as valuables perform better or worse depending on the economic, political, and social conditions.
To illustrate, when technology is booming, tech stocks outperform other sectors, and when emerging markets are growing, their funds could offer higher returns than the developed ones.
- Align your diversified holdings with your risk tolerance and goals, as assets have different levels of risk and return and diverse time frames for reaching maturity.
By way of example, if you are a conservative wealth builder who wants to preserve your resources and generate income, you may place your bets more in bonds, cash, and dividend stocks.
In contrast, if you act as an aggressive investor who prefers to grow wealth and capitalise on market movements, you could take a position in growth stocks, options, and commodities.
Review and rebalance your portfolio once a year or every quarter to ensure it stays in line with your target allocation and reflects any changes in circumstances, preferences, or trading conditions.
Case Study
This is the story of Emma, a retail investor who began cultivating monetary growth in the early 2000s.
Due to the dot-com boom, she tunnelled her vision towards investing in technology stocks. However, she learnt a valuable lesson in diversification following the bubble burst, which decimated the value of her portfolio.
Undeterred, Emma decided to rebuild her investment tactics by spreading her investments across a range of asset classes, including stocks, bonds, real estate, and international funds. Over the next decade, her diversified basket showed its strength.
While the 2008 financial crisis impacted global markets, her portfolio experienced less volatility compared to her earlier tech-only selection. Bond investments, in particular, provided stable returns that offset losses from stocks.
By the time the markets recovered, Emma’s diversified approach not only protected her assets but also positioned her to capitalise on the rebound by a long shot in the technology sector, which once again became a significant growth driver.
Emma’s story highlights the real-world benefits of diversification.
Such a strategy allowed her to weather market downturns more effectively and profit from the expansion in various sectors over time.
Don’ts of Investing
Even though taking a deep dive into the market is a way to build up wealth, it comes with risks and pitfalls that could lead to financial loss.
To avoid common slips rookie investors make, keep in mind these guidelines:
Do Not Invest More Than You Can Afford to Lose
You should not put your essential expenses, savings, or emergency funds at risk. That is because investing involves uncertainty and volatility, and there is no guarantee of getting your money back or earning a profit.
Therefore, enter the market only with surpluses you comfortably part with for a long time.
“Never test the depth of a river with both feet.” Warren Buffett.
Incorporate a budgeting strategy that includes investments while safeguarding indispensable expenses.
Here’s how to present it:
- Calculate Your Net Income: Start with understanding your monthly take-home pay, including all streams of earnings after taxes.
- Prioritise Essential Expenses: List your non-negotiable payments, such as housing, utilities, groceries, and healthcare. Ensure these are covered first to keep a stable economic environment.
- Set Aside an Emergency Fund: Before allocating money, create a safety net worth 3-6 months of living expenses. This fund acts as a financial buffer, protecting you from unforeseen circumstances without needing to liquidate investments at a loss.
- Determine Your Disposable Income: After essential expenditures and emergency savings, what remains is your disposable income, which can be used for discretionary spending and wealth growth.
- Allocate to Investments: Aim to commit a part of your disposable income to securities. A good starting point is the 50/30/20 rule, where 50% of your revenue goes to necessities, 30% to wants, and 20% for savings and long-term play. You might adjust these percentages, but always keep a balance that supports both your current lifestyle and future financial goals.
- Review and Rearrange: Your monetary situation and goals will evolve over time. So, by reviewing your budget and investment allocations, you are able to accommodate changes in income, expenses, and objectives.
Do Not Borrow Money to Invest
Avoid at any cost allocating funds from loans or credit cards, because this may deepen the financial hole and put you in debt if the market goes against you. Apart from that, the interest on loans and CCs is higher than what you’d receive on stocks or bonds. Way more they are indeed.
Leverage
In this context, leverage refers to the use of borrowed money to amplify potential returns from an investment. While leveraging increases venture capital beyond what your own would allow, it’s a double-edged sword that comes with heightened risks.
How Leverage Works
Imagine you have £1,000 to invest, and you’re considering buying shares of a company. If you commit your own money and the shares grow by 10%, your profit is £100.
However, if you borrowed an additional £1,000, making your total investment £2,000, a 10% increase would give you a benefit of £200 (minus any interest or fees on the funds on credit).
Risks vs. Rewards
The ugly side of leverage is that it magnifies losses just as it does gains. If the stake falls by 10%, you would not only lose £200 but also still owe the original borrowed amount plus interest.
Before the ink is dry, this action depletes your capital and leaves you in debt should the market doesn’t perform as expected.
Why Caution is Advised
Increased Losses
As highlighted, leveraging increases the potential for loss, not just the promise of profit. This can be damaging for beginners who might not have the experience to navigate through volatile market waters.
Interest Costs
The cost of borrowing sometimes outweighs the returns on an investment, especially if the investment’s performance is below expectations or if lending percentages are higher.
Market Volatility
Markets are unpredictable, and leveraging in unstable conditions may lead to financial distress if investments turn sour. For beginners, the key takeaway is that while leverage is a powerful tool for experienced investors, it poses dangers for those just starting out.
Investing within your own means and using only your capital is a prudent strategy that ensures you’re building your financial future on a solid, sustainable foundation.
Avoid Scams and Schemes
Stay away from those schemes that promise unrealistic profits and guarantees. Be wary if they are too good to be true.
Many scammers, fraudsters, and schemers prey on unsuspecting investors and try to lure them with promises of high returns, low risks, insider tips, or secret formulas.
To protect yourself from them, always, and I repeat, always research and verify the credentials and reputation of the source, and ask for independent advice before investing.
“A fool and his money are soon parted.” Benjamin Franklin.
One of the most effective ways to safeguard against scams is to utilise the resources provided by regulatory bodies, such as the Financial Conduct Authority (FCA) in the UK and the Securities and Exchange Commission (SEC) in the US.
Both institutions oversee financial organisations and products, ensuring that they adhere to strict standards of conduct and integrity.
How to Verify Regulation in the UK
FCA Register
The FCA provides an online registry (accessible via their website) where you can search for firms, individuals, or financial services to check if they are authorised or regulated. This tool is invaluable for confirming the legitimacy of the party offering the investment.
FCA Warning List
This is a compilation of businesses and people known to operate without FCA authorisation or that are involved in scams. Review this record as a routine step before making any move.
Company Details and Information
Legitimate institutions will provide their FCA registration number and official documentation verifying their regulatory status. This knowledge can be cross-referenced with the data found on the FCA’s register.
By taking the time to verify an investment’s compliance situation, you reduce the risk of falling victim to fraud, as regulated firms are subject to oversight and must meet stringent requirements designed to protect investors.
Investing with caution is your best defence against the sophisticated and convincing tactics employed by fraudsters.
Do Not Let Your Emotions Get in the Way
Passions and prejudices play tricks on the mind and interfere with any financial strategy.
Fear, greed, hope, and regret cause you to react on a whim, leading to buy high and sell low, chase fads and trends, hold on to losers and trade winners, or overtrade and incur unnecessary costs.
At the same time, confirmation, hindsight, overconfidence, or anchoring bias may also distort your perception and interpretation of information, causing you to ignore evidence, rationalise past mistakes, overestimate your skills or knowledge, or rely on irrelevant or outdated data.
To overcome these emotions and biases, have a clear and realistic plan, follow a disciplined and consistent approach, monitor and review your performance, and seek feedback and improvement.
“Investing is fun, exciting, and dangerous if you don’t do any work.” Peter Lynch.
To mitigate the impact of emotional decision-making in capitalising, create an Investment Policy Statement (IPS). It is a personalised document that outlines your investment goals, risk tolerance, time horizon, asset allocation, and criteria for selecting and evaluating opportunities.
Serving as a roadmap, it provides clear guidelines and strategies to keep you on course, even when market volatility or personal biases tempt you to deviate from your plan.
Creating Your IPS
Define Your Financial Goals
Start by knowing what you aim to achieve, whether it is retirement savings, buying a house, or funding education.
Assess Your Risk Tolerance
In all sincerity, evaluate how much risk you’re willing to accept in pursuit of your goals, considering time frame and your emotional capacity to handle market fluctuations.
Determine Your Asset Allocation
Depending on your objectives and comfort level, decide how you’ll distribute your money across stocks, bonds, or real estate.
Selection Criteria for Investments
Include factors such as performance history, fees, alignment with your values, and how to monitor their progress.
Review and Adjustment Procedures
Outline how and when to check your portfolio’s behaviour and, under what circumstances, you will adjust it. This includes rebalancing your asset allocation or revising your goals as your monetary situation evolves.
By adhering to your IPS, you make objective, disciplined decisions, reducing the likelihood of making impulsive choices based on fear, greed, or market rumours.
High-Level Risk Management Tools
As you become more comfortable with the basics of investing, incorporating advanced risk management strategies can help protect your portfolio from significant losses and enhance your investment outcomes.
Two fundamental techniques:
Stop-Loss Orders
This is an instruction to sell a security when it reaches a specific price. For instance, if you buy a stock at £100 per share, you might place a stop-loss order at £90. So, if the stock drops to £90, the stop-loss order is triggered, and the stake is sold, capping your loss at 10%.
Such approach is useful in volatile markets, allowing investors to set their maximum loss threshold in advance.
Position Sizing
It involves determining how much of your total portfolio to assign to a particular investment. It helps manage risk by ensuring that no single stake harms your overall basket.
To illustrate, you decide that any stock should represent more than 5% of your whole portfolio.
This way, even if one asset performs poorly, the impact is limited, shielding you from potential losses.
Both strategies are crucial for managing risks and securing that your range of products aligns with your tolerance and investment goals.
Final Thoughts
In this article, we have discussed basic rules of investing that help you reach your financial goals and avoid common pitfalls.
We have explored:
- Researching.
- Continuous learning.
- Diversify portfolio and reduce risk exposure.
- Don’t fall for scams and schemes that promise unrealistic returns and guarantees.
- Do not invest more than you can afford to lose.
- Do not borrow money to capitalise.
- Emotions and biases may affect a financial decision.
- How to verify if an investment is trustworthy.
- Creating an IPS.
Investing requires knowledge, discipline, and patience to succeed in the long term.
In a nutshell, the most important thing is to take action and begin putting your eggs in different baskets today. No matter how much or how little money you have, there’s always an opportunity to invest and grow your wealth.
The sooner you start, the quicker you will reap the benefits of fishing for returns.
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Thank you for reading, and happy investing!
Glossary of Common Investment Terms
Asset Allocation
The strategy of dividing investments among different asset classes, such as stocks, bonds, and cash, to optimise the balance between risk and return based on an individual’s goals, risk tolerance, and investment horizon.
Bonds
Debt securities issued by corporations or governments to raise money. Bondholders lend money to the issuer in exchange for regular interest payments and the return of the bond’s face value at maturity.
Diversification
The practice of spreading investments across various financial instruments, industries, and other categories to reduce exposure to risk from any single asset or sector.
Equity
Ownership interest in a company, typically in the form of stocks. Equity holders may benefit from dividend payments and capital gains if the value of the stock increases.
Interest Rate
The sum a lender charges a borrower for the use of assets, expressed as a percentage of the principal. It is the cost of debt for the borrower and the rate of return for the lender.
Liquidity
The ease with which an asset can be converted into cash without significantly affecting its market price. High liquidity indicates that the asset can be quickly sold, and vice versa.
Mutual Fund
An investment vehicle that pools money from many investors to purchase a diversified portfolio of stocks, bonds, or other securities, managed by a professional fund manager.
Portfolio
The collection of all the investment assets held by an individual or institutional investor, including stocks, bonds, cash, and more.
Risk Tolerance
An investor’s capacity to endure market volatility and the potential to lose money on investments. It is often influenced by the investor’s financial goals, income, age, and personal comfort level with uncertainty.
Stocks
Securities that represent partial ownership in a corporation. Stockholders may receive dividends and have potential for capital gains if the company’s value increases.
Volatility
The degree of variation in the price of a financial instrument over time, typically measured by the standard deviation of returns. High volatility indicates higher risk and the potential for rapid price changes.