Investing is a fundamental aspect of personal finance that holds immense importance in building wealth, achieving financial goals and securing a prosperous future. By allocating funds to various investment vehicles, people have the potential to grow their wealth, beat inflation and generate passive income. Investing also plays a critical role in retirement planning, allowing one to accumulate a substantial nest egg over time.
Although investments can be a powerful tool for wealth creation and financial security, it requires knowledge and a strategic approach. The golden rules of investing provide valuable principles to guide people in making informed decisions and increasing their chances of success in the investment world. These rules are time-tested and proven strategies that have been embraced by seasoned investors.
By understanding and applying these rules, people can set clear investment goals, diversify their portfolios, adopt a long-term perspective and maintain discipline. Whether you are a novice investor or have some experience in the market, these golden rules will serve as a foundation for making wise investment decisions and maximising your financial potential.
- Start today
If there was an eighth wonder in the world, it would be compound interest. Forward-thinking investors often hunt for smart and safe avenues to grow their funds. Being a strategic investor, you wouldn’t hesitate to consider compound interest as the ‘eighth wonder’. Simply defined, compound interest is the interest that you accumulate on top of the interest and principal amount. Let’s understand the power of compounding with an example:
Let’s suppose two friends, Thabo and Teboho, start investing L5,000 a year until they are 65 years old.
Assuming an average annual return of 10 per cent, Thabo starts investing at the age of 25 while Teboho begins at the age of 35. While the difference between the amount invested by Thabo and Teboho would be only L50,000, the difference in the funds accumulated by the time they turn 65 years would differ by about L950,000. Thabo would have L1.49 million, while Teboho would have only L545,000. That is the benefit of starting early, as compound interest grows your money significantly.
- Stick to a systematic investment plan
Investors need to keep their emotions in control while investing in markets. As American investor and author Peter Lynch once said: “Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” This is because selling out of fear keeps investors out of the market for far too long, causing them to lose a lot of ground in the early days of a rebound. Also when there a short-run rally the fear of missing out (FOMO) on any advances that may be ahead can overtake many who have been on the sidelines. However, missing the mark from time to time does not mean prudent investors should abandon their long term investing strategy and begin chasing recent market performance. On the contrary, times like this may present an opportunity for investors to refocus on what really matters in the long run for accumulating and preserving wealth. Usually, long term returns are closely linked to valuations. Investors should pay attention to metrics that reflect how expensive or cheap an investment is. If you go for high flying stocks at that particular moment maybe dismissing that these securities are relatively expensive at this point. With price to earnings ratios that are significantly higher than long term averages, these stocks can be expected to eventually revert to those averages, suggesting their recent outsized returns may not last.
While it is not possible to only avoid the best days in the markets, what it implies is that by trying to predict the best time to buy and sell, one may miss the market’s most significant gains. This can be an excellent strategy when it is difficult to call out a bottom in such markets.
Investors should invest strategically based on their goals. Rather than attempting to predict tops and bottoms in asset prices, they should set target allocations for various asset classes in their portfolio and periodically rebalance their investments back to those assigned allocations. Along the way, investors should allow for tactical adjustments based on evolving market trends or economic conditions, such as string potential performance in a certain sector or security, to inform decisions about when and how to deploy new capital or to selectively liquidate assets to fund spending needs. The key to this is to stay invested; cash on the sidelines is often a missed opportunity.
It is an excellent strategy for investors who want to take advantage of the dip but fear a further sell-off. Whether it is once a week or once a month, investors can put in a little at a time to ensure they are still investing in a structured way, but taking the emotion out of it. In a frothy market, stay focused on the bug picture and avoid trying to predict the market’s next moves, time in the market far more important than timing the market. Thoughtful risk management and asset allocation remain key to long term investment success.
It is important to note that fundamental market conditions change and investors need to adapt accordingly. If you are an active investor for example, during periods of muted equity returns, actively selecting securities maybe more likely to help investors capture superior risk- adjusted performance than passively tacking the index. It is essential not to look for a needle in a haystack but, instead, just buy the haystack. As such it is essential to realise that, risk management is key to avoiding losses that exceed investors’ acceptable boundaries. In investing, the mathematics of gains or losses are said to be ’asymmetric.’ That some investments may offer a more attractive potential return, for a given level of risk, than others. As such, investors, need to build diversified portfolios with a goal to maximise potential upside and minimise the downside- all within the boundaries of their personal tolerance for risk. For example, someone who invested their funds in Tesla would have lost 68 per cent last year, while if you invested in the Nasdaq 100 index, the loss would have been only 34 per cent. Those losses would have dropped to 20 per cent if you bought into the S&P 500 index and even further to 14 per cent if you had a 60/40 equity-bond portfolio. Therefore, it is advisable to maintain a broad diversification among asset classes and even sectors to mitigate the volatility. It is advisable to maintain a broad diversification among asset classes and even sectors to mitigate the volatility
Investors should diversify in a mix of cash and income-producing securities rather than solely in equities. The goal should be to achieve reasonable returns that outperform inflation while keeping volatility under control.
- How to start
Decide on your goal – what do you need the funds for and when are they required? This step is essential as it will help you to decide on the appropriate risk-return strategy. However, before investing, you should reduce your debt and set aside an emergency fund so you are not forced to sell your fund when markets are down because you need cash. And remember – start now and invest regularly.
The bottom line is that; investors need to think about the big picture. Do not try to predict market moves, diversify your portfolios, stay close to your strategic asset allocations, rebalancing as needed. it is important to note that investing involves risks and there is no guarantee of positive returns. It requires careful consideration, an understanding of the investment vehicles and a long-term perspective.
Until next week enjoy making money on capital markets.
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