Key Attitudes and strategic frameworks for Intelligent and successful investors…
Meanwhile, creating a short list of everything that a beginning investor should know inevitably runs the risk of excluding many vital points. Indeed, successful investors are bound to differ widely on what they would include in their top ten lists if they were pressed to replicate this exercise.
That said, we offer what we hope is a useful checklist to help you get started as a successful investor. We have chosen to emphasize key personal attitudes and overarching strategic frameworks that, in our opinion, will help you to become an intelligent investor.
- Have a plan, prioritize saving, and know the power of compounding.
- Understand risk, diversification, and asset allocation.
- Minimize investment costs.
- Learn classic strategies, be disciplined, and think like an owner or lender.
- Never invest in something you do not fully understand.
1. Have a Financial Plan
The first step toward becoming a successful investor should be starting with a financial plan—one that includes goals and milestones. These goals and milestones would include setting targets for having specific amounts saved by specific dates.
The goals in question might include, for example, having enough savings to facilitate buying a home, funding your children’s education, building an emergency fund, having enough to fund an entrepreneurial venture, or having enough to fund a comfortable retirement.
Moreover, while most people think in terms of saving for retirement, an even more desirable goal would be to achieve financial independence at as early an age as possible. A movement devoted to this goal is Financial Independence, Retire Early (FIRE).
While it is possible to create a solid financial plan on your own, if you are new to the process, you might consider enlisting professional help from someone such as a financial advisor or financial planner, preferably one who is a Certified Financial Planner (CFP®). Finally, do not delay. Seek to have a plan in place as early as possible in your lifetime, and keep it a living document, updated regularly and in light of changed circumstances and goals.
2. Make Saving a Priority
Before you can become an investor, you must have money to invest. For most people, that will require setting aside a portion of each paycheck for savings. If your employer offers a savings plan such as a 401(k), this can be an attractive way to make saving automatic, especially if your employer will match all or part of your own contributions.
In setting up your financial plan, you also might consider other alternatives for making saving automatic, in addition to utilizing employer-sponsored plans. Building wealth typically has aggressive saving at its core, followed by astute investing aimed at making those savings grow.
Also, a key to saving aggressively is living frugally and spending with caution. In this vein, a wise adjunct to your financial plan would be creating a budget, tracking your spending closely, and regularly reviewing whether your outlays are making sense and delivering sufficient value. Various budgeting apps and budgeting software packages are available, or you can choose to create your own spreadsheets.
3. Understand the Power of Compounding
Saving and investing on a regular, systematic basis and starting this discipline as early as possible in life will allow you to take full advantage of the power of compounding to increase your wealth. The current protracted period of historically low interest rates has diminished the power of compounding to some extent, but it also has made starting early to build savings and wealth more imperative, since it will take interest-bearing and dividend-paying investments longer to double in value than before, all else equal.
4. Understand Risk
Investment risk has many aspects, such as default risk on a bond (the risk that the issuer may not meet its obligations to pay interest or repay principal) and volatility in stocks (which can produce sharp, sudden increases or decreases in value). Additionally, there is, in general, a tradeoff between risk and return, or between risk and reward. That is, the route to achieving higher returns on your investments often involves assuming more risk, including the risk of losing all or part of your investment.
As a critical part of your planning process, you should determine your own risk tolerance. How much you can be prepared to lose should a prospective investment decline in value, and how much ongoing price volatility in your investments you can accept without inducing undue worry, will be important considerations in determining what sorts of investments are most appropriate for you.
At its most basic level, investment risk includes the possibility of a complete loss. But there are many other aspects to risk and its measurement.
5. Understand Diversification and Asset Allocation
Diversification and asset allocation are two closely related concepts that play important roles both in managing investment risk and in optimizing investment returns. Broadly speaking, diversification involves spreading your investment portfolio among a variety of investments, in hopes that subpar returns or losses in some may be offset by above average returns or gains in others. Likewise, asset allocation has similar goals, but with the focus being on distributing your portfolio across major categories of investments, such as stocks, bonds, and cash.
Once again, your ongoing financial planning process should revisit your decisions on diversification and asset allocation regularly
6. Keep Costs Low
You cannot control the future returns on your investments, but you can control the costs. Moreover, costs (e.g., transaction costs, investment management fees, account fees, etc.) can be a significant drag on investment performance. Similarly, taking mutual funds as just one example, high cost is no guarantee of better performance.
Investment costs and fees are often a key determinant of investment results.
7. Understand Classic Investment Strategies
Among the investment strategies that the beginning investor should understand fully are active versus passive investing, value versus growth investing, and income-oriented versus gains-oriented investing.
While savvy investment managers can beat the market, very few do it consistently over the long term. This leads some investment pundits to recommend low-cost passive investing strategies, mainly those utilizing index funds, that seek to track the market.
In the realm of equity investing, value investors prefer stocks that appear to be relatively inexpensive compared to the market on measures such as price-earnings ratios (P/E), expecting that these stocks have upside potential as well as limited downside risk. Growth investors, by contrast, see greater opportunity for gain among stocks that are recording rapid increases in revenues and earnings, even if they are relatively expensive.
Income-oriented investors seek a steady stream of dividends and interest because they need the ongoing spendable cash, they see this as a strategy that limits investment risk, or both. Among the variations of income-oriented investing is focusing on stocks that offer dividend growth.
Gains-oriented investors are largely unconcerned about income streams from their investments and instead look for the investments that seem likely to deliver the most price appreciation in the long term.
8. Be Disciplined
If you are investing for the long term, according to a well-thought and well-constructed financial plan, stay disciplined. Try not to get excited or rattled by temporary market fluctuations and panic-inducing media coverage of the markets that might border on the sensationalistic. Also, always take the pronouncements of market pundits with a grain of salt unless they have lengthy, independently verified track records of predictive accuracy. Few do.
9. Think Like an Owner or Lender
Stocks are shares of ownership in a business enterprise. Bonds represent loans extended by the investor to the issuer. If you intend to be an intelligent long-term investor rather than a short-term speculator, think like a prospective business owner before you buy a stock, or like a prospective lender before you buy a bond. Do you want to be a part owner of that business, or a creditor of that issuer?
10. If You Don’t Understand It, Don’t Invest in It
Given the proliferation of complex and novel investment products, as well as of companies with complex and novel business models, beginning investors today are faced with a vast array of investment choice that they may not fully understand. A simple and wise rule of thumb is never to make an investment that you do not fully understand, particularly when it comes to its risks. A corollary is to be very careful about avoiding investing fads, many of which may not stand the test of time.
Before investing, it is critical to know what your goals and objectives are. Whether it be to fund retirement, purchase a home, or undertake a new business venture, knowing what you’re working towards will help you choose an investment to help you meet your goals. It is also important to know the basics about investing—such as risks, fees and costs, and investment strategies—and understand the investment you’re prospecting.
While there are many investment categories, the four basic types are stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Stocks are shares of ownership in a company. Bonds are essentially loans made by the investor to the issuer, who promises to pay the principal at maturity and interest over the bond’s term. Mutual funds are funds in which multiple investors pool their money together to purchase stocks or other securities, and ETFs are like mutual funds but are traded on national stock exchanges.
Many prospective investors believe they must have a lot of money to begin investing. However, many investments have low thresholds, giving new investors opportunities to start their journey. You can begin investing with $100 or less. For instance, you could purchase shares or fractional shares of stock, use a robo-advisor to invest based on your goals, contribute to a retirement plan, or invest in a mutual fund. The options are plenty.
The Bottom Line
As a new investor, choosing the right investments or investment strategy can be intimidating, and the advice on how to proceed is as diverse as the selection of investments from which to choose. Despite the innumerous recommendations, building your knowledge and having a solid understanding of investing and your goals is key to making informed decisions that will likely yield favorable results.
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