For some of us, investing is a means to a clear end. For others, the end game can be a little fuzzy, but Paul Clitheroe* says the basics of how to invest are still much the same.
Having a goal to work towards can make it easier to decide where to invest, for how long, and how much to invest on a regular basis to reach your goal.
But even if you don’t have a specific purpose or target to work towards, investing still plays a valuable role in our financial lives.
Investments can be a source of additional income, and they help to grow wealth over time, making us more financially secure – two achievements definitely worth working towards.
If you don’t have a clear motivation for investing, it makes sense to follow some basic rules.
You may find you develop goals over time, and if you have started with a strong foundation, it’s a lot easier to finetune your portfolio rather than radically pivoting your approach to meet those goals.
With this in mind, here are three key principles to get started.
Understand that risk equals returns
Taking excessive risk chasing a big return is the number one reason why investors lose money.
If you see an investment offering a high return, don’t say “Oh good” ask “Why?” High returns always go hand-in-hand with increased risk.
I’m not saying you should take no risk – that would mean earning little or no return.
Just be aware of risk.
Ask questions and understand the true nature of risk in any investment before you put money on the table.
Diversify your investments
Spreading your money across different investments smooths out long term returns and reduces overall portfolio risk.
How you diversify depends on your age, income, family and so on.
The younger you are the less diversification you are likely to have.
But as you get older, it becomes easier to diversify as your wealth grows.
Invest in growth assets for the long term
A growth assets is an investment that grows in capital value over time as well as producing ongoing income.
Shares, property and many exchange traded funds all tick the box for growth assets.
The appeal of growth investments lies in their ability to outperform inflation.
They rise in value over time, outpacing cost of living increases.
That way the real (after-inflation) value of your money doesn’t fall behind.
Growth assets also deliver tax advantages and generate more income as time goes by.
The catch with growth investments is that they don’t continually rise in value.
As we’ve seen lately, both shares and property can fall in value at times.
This highlights the need to hold onto growth assets for the long term – at least five-years-plus, to smooth out volatility.
If you’re unsure where to get started, it may be worth speaking to a licensed financial adviser.
But for many people, starting out gradually and steadily growing investments across several different asset classes, can build your confidence and experience as an investor.
*Paul Clitheroe is Chairman of InvestSMART, Chair of the Ecstra Foundation and chief commentator for Money Magazine.
This article first appeared at investsmart.com.au.
