6 Critical Things for Making Investment Decisions
It’s never easy when it comes to making investment decisions. While sometimes we wake up and decide to buy a particular asset class – I have done so on a few occasions- it usually doesn’t work out well in the long run. As long as any investment decisions are not aligned with your financial goals and objectives, there is a high likelihood the decisions will bite you back in a**.
Given the current market conditions, many investors wonder whether they should change their portfolios while others are already implementing the changes. While no one is better suited to tell you how to manage your portfolio when the market is volatile, you need to make some considerations to ensure you achieve your investment goals and place your money in the right places.
Define Your Financial Roadmap
The first step to starting investing is evaluating your overall financial position, especially when it’s the first time to draw up a financial plan. That means having a detailed outlook of your income, debts, and savings. Once you know where you stand, you can easily outline your objective for investing, goals, and risk tolerance level.
Remember that you don’t have a 100% guarantee of making money from your investment. In fact, you might end up losing your capital. Whatever money you set aside for investing, ensure it does not affect your daily living expenses.
By this, I mean having an emergency fund to cater to any emergencies like losing your income source, so you don’t rush to liquidate your investment. An emergency fund will also safeguard your financial needs in case the investment does not work.
While drawing your investing road map, also consider your investment time horizon. Are you looking for a long-term or short-term investment period? Will you need to withdraw your investment in the next year to meet other financial needs, or you’re investing for a longer period like 5/10/15 years?
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Evaluate Your Risk Tolerance Levels
Risk tolerance is the variability degree in returns that you’re willing to take in any investment. Your risk appetite will define what asset classes suit you. If you know how much risk you are willing to take or tolerate, ensures you don’t wind up with investments that keep you up at night. Once you start investing, ensure you extensively research any investment you’re about to undertake and understand its risk levels.
Asset classes with high-risk levels like stocks will also have higher returns in the long run compared to low-risk investments like cash and equivalents. While cash and equivalent investments are highly liquid and have lower risks, there’s the inflation risk to worry about. Inflation risk is the risk of rising levels of inflation eroding or outpacing your small returns in time.
“Every once in a while, the market does something so stupid it takes your breath away.” – Jim Cramer.
The bottom line is that no investment comes without related risks. The risk value differs between asset classes, and you should be prepared for the volatility of the market when investing.
Think About How You Want to Invest
For starters, you can invest as an individual, where you are in charge of doing all the research and transactions related to buying and selling of asset classes in your portfolio. I’d recommend this strategy for anyone who has time on their hands because there is a lot of research involved. You also need to understand financial statements, analyze and interpret the results for any company you want to invest in.
Alternatively, you can invest through a managed fund, like a mutual fund, exchange-traded fund (ETF), or an index fund. Managed funds usually use pooled money from various investors and invest in multiple assets.
A managed fund will also have a dedicated manager in charge of managing the fund’s investment decisions and research activities. All you have to do is say what you want to invest in, bonds, or stocks, among others, and how much risk you’re willing to take. You also need to provide your investment horizon and the investment approach.
You also need to consider whether you want an active or passive management approach for your portfolio, whether you invest as an individual or through a managed fund. Passively managed funds focus solely on tracking a market index, leading to lower buy and sell transactions and costs. Actively managed portfolios work to beat the market index and earn higher returns, leading to more transactions and costs.
Related read: DIY Investing: How To Do It Like a Pro
Asset Allocation and Diversification
Yes, do not put all your eggs in one basket, even in investing. Having different asset classes in your portfolio helps diversify risk and ensure you earn a return from one of the underlying assets when the other is not performing well.
For example, you have an asset mix of bonds and stocks in your portfolio, since bonds are less riskier than stocks. If you want to focus solely on stocks, which is possible, ensure that you invest in stocks from different industries and sectors for better diversification. It’s also advisable that you avoid investing in your employer’s stocks. If the company goes bankrupt or winds up for whatever reason, you risk losing your capital and a source of income.
Asset allocation is where you determine what percentage of each asset class goes into your portfolio. If you are mixing bonds, stocks, cash, and equivalents, and real assets in your portfolio, you can allocate each of these assets based on your goals, risk tolerance, and return expectations.
Asset classes with high risks and returns can have a higher percentage in your portfolio if you have a long-term investment horizon and a high-risk appetite. You can then allocate a lower portion to other asset classes with lower risks for diversification.
Once you’ve started investing, keep a close outlook on your portfolio and rebalance it when needed. Rebalancing refers to realigning your asset classes to ensure you maintain your desired or original asset allocation and risk levels.
Consider Using Dollar Cost Averaging Strategy (DCA)
The dollar-cost averaging strategy is ideal if you have a low tolerance to risk and long term investment horizon. It involves investing a fixed amount in the same stock or fund over a period rather than investing a lumpsum amount.
First, DCA eliminates the hassle of trying to time the market since the purchases occur whether the prices for the underlying asset have increased or not. Second, it protects you from investing all the money you have at the wrong time.
Think Twice
Yes, when any investment deal is too good, think twice. Go back to the drawing board, do your research, conduct interviews where necessary, and make the right call.
By now, I am sure you are aware of the pyramid schemes in Kenya that promise investors quick returns in a short period, which are making a big comeback. If you see any signs of a Ponzi scheme from an investment, you better take a break and look for a better investment firm, one that is regulated and has a long history in the investment industry.
Nekesa
Yes, any investment is a risk. Depends on how much risk you are willing to take . Very good read ?
Enid Kathambi
Thank you!
John
Sasa enda uwe lecturer ama fungua consultancy. You doing great and your reads are quite eye opening.
Enid Kathambi
Thank you, John, for taking the time to read the article. I am glad you learned something. I will be launching podcasts and webinars in the near future. Be on the lookout.