A Beginner’s Guide to Investing
Investing is the act of buying something with the potential for it to grow in value, and be later sold for a higher price.
We invest for various reasons including hoping to supplement income in the future, to supplement income now such as with rental property, and importantly to keep up with inflation. But returns are not guaranteed, so all investments carry risk.
Suitability of an Investment
When considering appropriate investment options; think about both liquidity and the level of risk you are willing to take.
Liquidity is the ability to turn the investment into cash and the time frame it takes. For example, cash is extremely liquid. You can get it from an ATM even. Stocks and bonds are liquid but may take a few days to sell and turn into cash depending on your holdings. On the other hand, something like a house is not very liquid. It usually takes months to list, sell, and close on a property. Will you need access to ‘just-in-case’ cash or could you lock away the money for a few years? Your need to access the money will determine which types of investments would be best suited.
Risk is the likelihood of losing an investment. High-risk investments offering greater returns at a lower level of certainty. On the other hand, lower-risk investments may provide lower returns with more chance of guarantee.
Systematic vs Unsystematic
Systematic risk refers to the general level of volatility over the entire stock market. Alternatively; unsystematic risk refers to the probability of loss in a specific industry or security.
An example of systematic risk includes the inherent risk across the entire stock market, such as a government tax increase on all transactions. It may also include natural disasters or anything that affects the entire economy.
Things like strikes come under unsystematic risk as strikes are an industry-specific issue. It would also include company-specific threats such as a security breach or lawsuit. The level of risk can be mitigated by diversifying your investments over multiple assets.
Asset Allocation
Asset allocation refers to the spread of your investments. An investor wanting a diversified portfolio considers the following before investing:
Returns
Growth potential
Safety or risk
Liquidity
Potential tax savings
Transaction costs
Diversification
This is the act of investing in a number of pots; in a range of areas to avoid “putting all your eggs in one basket.” Diversifying may lower your overall risk by spreading out your investments into:
Sectors such as finance or technology
Location such as US or international
Size of company such as large cap or small cap companies
Dollar-Cost Averaging
As discussed, the markets can go both up and down; meaning that the value of your investments can increase or decrease. By consistently investing over the course of time, emotions can be removed from the process. This, in turn, commits the investor to regular contributions and takes advantage of up days and down days in the market to help even out when you are investing.
A financial planner works with you to determine the most suitable investment opportunities and plan for the future. Schedule a call with me today to start the discussion.