3 Principles to Guide Investors
1. Invest – Now and regularly
Yes I know, ‘invest’ as the first principle in a guide for investors might seem a bit obvious, but most people are not proactive enough in starting their investing journey.
The sooner you start this journey, the higher your potential gains are. The reason: compounding. Compounding is the most useful tool in every investor’s belt. The compounding formula, FV (future value) = P*(1+r)t, means that whilst you can’t necessarily control the amount you have available to invest, ‘P’, nor what the economy or financial markets will do, ‘r’, you CAN control ‘t’, the time your money is invested. The sooner you start investing, the bigger this number and the longer you have compounding working for you. For more information on how compounding works, see our article: Mathematically, NOW is always the best time to start a Financial Plan.
Investing ‘regularly’ and in a variety of different funds is also a core principle to adopt when starting your investment journey. This means creating a diverse portfolio containing a mix of assets. The thought behind this is, essentially if one asset fails you have a mix of other investments spread across a variety of companies, industries etc.. to minimise the impact that this one failed investment has on your overall portfolio. The the cooperation of this diverse group of assets to achieve your financial goals, both long and short-term, is the basis of a successful financial plan.
2. Understand your goals and risks and the interaction between the two
Before starting your investment journey, you need to set out your financial goals and harness an understanding of the risks involved in various aspects of investing. Doing this will uncover how the two work hand in hand.
Fundamental in getting to grips with this principle is understanding the process of market volatility and how you can benefit from it in the long-term. Assets fluctuate up and down. This is part of the investment journey. But something that all investors must learn is that equities will almost always produce gains in the long term. Holding firm during periods of volatility consistently rewards the investor in the long-term, helping to achieve long-term financial goals.
Important to this principle is the idea that diversification is imperative in mitigating risk. Cheap, well-managed, highly diversified index funds mitigate investment risk as investments are spread across a range of companies, industries, countries etc.. This removes the risk associated with a business folding or an industry or sector suffering a big cyclical dip, as the rest of the investments in the index fund are there to balance it out if you suffer losses in one area. Diversification also means you don’t have to make decisions on each stock as the index is constantly rebalancing. This reduces the risk of making poor decisions as lots of small holdings balance out one bad investment.
Understanding how financial goals and risks work hand in hand is crucial to investing. If you need money in the short-term for school fees, a house deposit or a holiday, then investing in equities is far too risky as there is a chance you may need to withdraw your money at a time when markets are down. The stock market is a dangerous place for short term investors. Instead, cash is a great option, as there is minimal volatility associated, so you know your money is safe and will be readily available when required. At the moment, you can also earn good returns due the continuous rise in base rate by the Bank of England. For more information about the best cash options for you, read our article: What to do with cash?
If you do want to take on the stress of being a short-term investor in the stock market, there are still ways you can mitigate risk. Having an emergency fund is a way of ensuring that if you need money immediately, but you’re invested in an equity suffering a dip at that moment in time, you have a pot that can cover you whilst your investment rides out this volatile period, ultimately meaning you don’t have to take heavy losses on this investment.
For goals such as saving for retirement, a college fund for young children, or that dream holiday you’re already planning for the distant future, long-term investments in equities beat everything else. Suffering through periods of volatility almost always provides high returns as the reward. And with a diversified portfolio, you are much less likely to incur losses over a longer period of time.
Always keep the end point of where you want to be in your mind. If you need money in 3 months’ time, your portfolio should look drastically different than it should for building wealth over 25 years.
3. Ignore the noise
If you are in it for the long-run, don’t get involved in the media panic and market speculation in the press. It will just cause you unnecessary stress.
We know it is easy to let media headlines trigger anxiety – not just in investing but life in general. But just keep reminding yourself of our second investment principle: understand the long-term functioning of financial markets and remember that history tells us that almost every time stock markets reward investors that stick around for the long-run.
Avoiding rash decision making and ensuring that you do not let your own or other people’s emotions impact your investment strategy is a crucial principle to take into your financial plan.
Ultimately you need construct your plan to fit your goals.
Ask yourself these questions using the three principles above to determine the right investment approach for you:
- What is the purpose of your wealth?
- Do you need access to cash immediately to feel financially relaxed?
- Do you need to boost your income through investment?
- Is investing for future generations a significant part of your financial plan?
Your financial goals should form the foundation of your investments.
If you want to have a chat about implementing these principles into your financial plan, please book a no obligation 15-minute call free of charge with one of our professional financial advisers.