Investing for the long term is a habit that, once begun, will stand us in good stead for a lifetime. However, it can be daunting to take the first step because a number of difficult questions can go through your mind. How much should I put aside? What should I invest in? And perhaps most importantly, how much risk can I afford to take with my money? First time investors have a lot to think about before they embark upon their journey.
The good news is that there are fairly simple solutions, with discipline as the starting point and then determination to stay the course. By following a few basic tenets given below, you could easily achieve investment success:
Set aside money for emergencies: There are many reasons why you might need access to a substantial sum of money at a short notice, such as an unplanned purchase, or a medical emergency. A good rule of thumb is to set aside four to six months worth of your average monthly income aside in cash, or in very “liquid” instruments (that is, those that can be converted to cash at a short notice such as cash funds).
Understand your risk tolerance: Each of us is unique in the amount of risk we are willing to subject our money to. Do the ups and downs in the stock market give you sleepless nights? Do you have a sufficient regular income that satisfies your general expenses and wish some of your money generates higher returns?
The answers to these questions will give you an indication of your risk tolerance, and you should allocate money between stocks and bonds based on them.
Getting your risk profile mapped by a good investment adviser is the best way to be clear about your risk tolerance.
Develop a financial plan with your adviser: Talk to your investment adviser to develop a “road map”, or your own personal financial plan. As part of it you would need to identify
■ What your primary life goals are, and how much money you will need to attain them
■ The amount of money you will need for regular expenses and contingencies, should they arise
■ How you will beat the corrosive effects that inflation will have on your money over time
■ The time you should remain invested to reach your goals
■ The amount of money you should allocate to different financial instruments such as mutual funds, stocks, bonds and cash, and how that mix should change over time
Choose your financial instruments: You may fancy yourself to be an expert stock picker, but most of us do not have the time or research capability to pick winning stocks all the time.
Mutual funds are the best way to quickly and efficiently buy a basket of stocks or bonds, hand-picked by professional portfolio managers. This way you can achieve a high level of diversification and quality returns through a few good funds, and at a fairly low cost. Here are the two benefits mutual funds provide over direct investments or deposits:
■ Dividends earned from mutual funds are not taxed in the hands of the investor, while capital gains are also tax-free compared with tax on interest income.
■ Gains on trades done by fund managers are not taxable while each trade you do on your portfolio will be taxed.
Invest regularly: We may be tempted to invest when the stock market is on a tear, and pull out money when we see it fall, but this is the wrong approach! Investing regularly, through market ups and downs, is the way to save for the future. When the market falls, you are able to buy your funds at a lower unit price. When it rises, your existing units gain in value. Ask your adviser about systematic investment plans, which will help you invest regularly.
Stay the course: Remember, it is time and not timing in the market that helps us attain our investment goals.
Research has shown that missing just the 10 best days of stock market performance in the last 10 years (up to December 31, 2010) would have delivered just 8.65 per cent in annual returns versus 17.17 per cent if you had remained invested throughout the entire period. Also, stick to the asset allocation that your adviser has determined is best for you, and rebalance your portfolio regularly to maintain that mix.
This means that when one part — let’s say bonds — gains in value to the point where your asset allocation is not being maintained, sell some bonds and buy stocks to maintain the right mix. This way, you are buying low and selling high, and that is what investing is all about.
Review regularly but not everyday: Keep an eye on your portfolio to make sure that you are on track — but there is no need to look at it every single day!
Investing is for the long term, so a steady disciplined approach through market gyrations will ensure that you reach the goals that you have set out for yourself.