Investing – Six principles to consider
Successful investing involves making choices that meet your unique needs today and your financial goals for the future. Your personal circumstances will affect your decisions every step of the way. Whether you are saving for a home, retirement or your child’s education, here are six investing principles to consider:
1. Invest for the long-term
It may seem very obvious but the longer you invest, the bigger the potential effect of compound performance on the original value of your investment. Many investors will be familiar with the term ‘compounding‘ from owning cash savings accounts. The term refers to money multiplying itself by earning a return on the return. Over time, compounding can make a significant difference.
Your investments can also benefit from compounding in a similar way if you reinvest any income you receive. You should remember, however, that the value of stock market investments will fluctuate, causing prices to fall as well as rise and you may not get back the original amount you invested.
2. Diversify to spread risk
Spreading risk across a wide range of investments is an effective way to reduce your risk exposure and increase potential returns over the long-term. Holding a mixture of different types of investments can help cushion your portfolio from downturns, as the value of some investments may go up while the value of others may go down. Shares, bonds, property and cash react differently in varying conditions, and opting for more than one asset class can help to ensure your investments won’t all rise or fall in value at the same time.
Holding a portfolio of investments with a low level of correlation can help to diversify the perils associated with investing in individual assets and markets, as well as less visible hazards such as inflation risk – the possibility that the value of assets will be adversely affected by an increase in the rate of inflation.
Geographical exposure and long-term investing are other ways of spreading risk. Above all, investors should aim for a level of risk they are comfortable with, which reflects their investment objectives.
3. Understand your investments
While a well-constructed portfolio can produce a healthy return for investors, the opposite is also true. It is easy to incur permanent losses by putting money into an asset that behaves in an unexpected way. Investors should always set aside time to try and understand what it is they want to hold.
The type of investments you choose will also depend on whether you’re saving for long-term or short-term goals. For your long-term goals, you may want to consider long-term, growth-oriented investments. Your short-term goals call for investments that are more conservative and more accessible. For example, if you’re investing to save for a house deposit, you’ll want quick and easy access to your funds.
4. Avoid portfolio complacency
The mix of investments within your portfolio is also known as your portfolio’s asset allocation. A portfolio should typically hold a combination of savings, income and growth investments. History is no indication of how an investment might act in the future, and investors should always try to weigh the potential risks associated with a particular investment alongside the prospective rewards.
One consideration is to invest smaller amounts over time – also known as ‘pound-cost averaging’ – to benefit from lower average costs than infrequent purchases. For example, your money will buy more units or shares within a fund when prices are low, and fewer units or shares when prices are high. Provided the fund gains in value over the long-term, you’ll have the opportunity to profit from your purchases during short-term price declines.
5. Seek broader opportunities
As we witnessed in 2008 following the collapse of US investment bank Lehman Brothers, unexpected or adverse news flow can have a significant effect on Stock Market performance. More recently, the crisis in Greece may well present broader opportunities in European stocks for investors willing to take on a certain level of risk.
Indeed, there have been times when highly cash-generative, defensive businesses capable of creating value in a range of market conditions have been subjected to the same negative sentiment that has driven down the price of stocks more sensitive to economic cycles and those that are poorer quality.
6. Focus on the real rate of return
Inflation, taxation and charges (such as dealing, switching and ongoing charges) are three of the factors that can affect the real rate of return on your investment. There are certain options that can reduce costs, including the use of tax-efficient wrappers, namely Individual Savings Accounts (ISAs), private pension plans and employment ‘save as you earn’ schemes.
There are also inflation-protected instruments, such as index-linked bonds (interest-bearing loans where both the value of the loan and the interest payments are related to a specific price index – often the Retail Prices Index), National Savings investments or commercial property holdings, where rents can often be increased in line with the rate of inflation.
INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.
THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED. PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.