You’ve been in the world of investing for some years as of now. But you haven’t reaped your desired returns. What lessons do you need to learn? What can you do for your money to work for you?
Here are some of the principles of modern finance, which I got from the book that I read and can definitely be of help to you in investing your nest eggs wisely so as to avoid the worst financial blunders. These lessons can help you about your personal investment decisions.
Lesson 1: Know your investments. The absolute bedrock of a sound investment strategy is to be realistic and prudent in your investment decisions. For important investments, study the materials and get expert device. Examine carefully how do they get such returns. Be careful of quick rich schemes. Be skeptical of approaches that claim to have found the quick route to success. You can’t get rich by listening to your barber or consulting the stars such as astrology and clairvoyance. Hunches work out to nothing in the long run.
Lesson 2: Diversify, diversify. One of the major lessons of finance is the advantage of diversifying your investments. “Don’t put all your eggs in one basket” is one way of expressing this rule. By putting funds in a number of different investments, you can continue to average a high yield while reducing the risk.
For example, suppose that stocks and real estate each have average returns of 10%. A portfolio that contains equal shares of each investment would also have an average return of 10%. But because a bad year for one of them may be balanced by a good year for the other, the risk of the overall portfolio can be reduced. Calculations show that by diversifying their wealth among a broad array of investments such as different common stocks, bonds, real estate, domestic and foreign securities, people can attain a good return while minimizing the downside risk on their investments.
Lesson 3: Consider common-stock index funds. Investors who want to invest in the stock market can achieve a good return with the least possible risk by holding a broadly diversified portfolio of common stocks. A good vehicle for diversifying is an index fund. This is a portfolio of stocks of many companies, weighting each company in proportion to its market value, and often tracking a major stock index like the Dow Jones or S&P 500. Here in the Philippines, there’s the Philippine Stock Exchange Index Fund.
Lesson 4: Minimize unnecessary expenses and taxes. People often find that a substantial amount of their investment earnings is nibbled away by taxes or expenses. For example, some mutual funds charge a high initial fee when you purchase the fund. Others might charge a management fee of 1 or even 2 percent of assets each year. Additionally, heavily managed funds have high turnover and may lead to large taxes on capital gains. Day traders may find great enjoyment in lightning movements in and out, and they may strike it rich, but they definitely will pay heavy brokerage and investment charges. By choosing your investments carefully, you can avoid these unnecessary drains on your investment income.
Lesson 5: Match your investments with your risk appetite. You can increase your expected return by picking riskier investments. But always consider how much risk can you afford financially and psychologically. As one adviser said, investments are a trade-off between eating and sleeping well. If you get insomnia worrying about the ups and downs of the market, you can maximize your sleep by keeping your assets in safe haven investments such as treasury bonds.
If you want to eat well and can tolerate disappointments, you might invest more heavily in stocks including those in foreign countries and emerging markets, and incorporate more volatile small companies into your portfolio rather than concentrating on short-term bonds and bank deposits.