The markets have seen some investing greats like Benjamin Graham, Warren. E. Buffet and Peter Lynch and these gentlemen were kind enough to impart a few lessons too. There are some classic books available that inform an intelligent or at least willing-to-learn investor the secret to successful investing, but mistakes still happen; investors rarely learn from these priceless lessons. However, the crux of the lessons is here: the need to devise and implement a sound investment plan.
Goals and objectives — You can’t Shoot if You can’t Point: What are you investing for? What, really, are your objectives? Are you investing for retirement? Is there a reason why you are keeping this money aside? What are your future major expenses going to be? Say, if you have to purchase a house, a car, accumulate cash for kids’ education and college, take a vacation, etc. Have you made plans for the above goals? Do you have a mix of both short-term and long-term goals?
A simple way to set aside goals is to clearly demarcate them as short-term and long-term goals and then apply the SMART rule to each one of these goals. SMART stands for Smart, Measurable, Attainable, realistic and Time-bound. Remember that investing strategies differ for long-term and short-term goals so you must incorporate these differences in your plan accordingly.
Risk Appetite – How much Can You Take? Risk-return trade off is something you have to get comfortable with before you enter the big world of financial planning and investing – it basically suggests that the more risk you take, the more returns you get to enjoy. Each of us has a different risk appetite and it can never be comparable. You must try to understand how much of risk you would be willing to take and then invest accordingly.
Risk appetite automatically changes with age and responsibilities. A young investor can be understandably brash and can have a high risk appetite while a person nearing retirement would like to see her money stashed away in a relatively low-risk investment vehicle. The balancing scale will tilt from high-risk to low-risk with age anyway, but the actual allocation of this risk is best managed by you.
Prudent Benchmarks – Who are you Pitting Against? The only way you get to know how well your portfolio is doing is to pit it against other portfolios (this is impossible and not even necessary) or to pit it against a standard benchmark — like the NASDAQ, NYSE etc. Like a relentless guide, this benchmark constantly and faithfully guides your faculties to think, act and take decisions based on the information you would constantly derive. However, remember that more often than not, these benchmarks do better than most of the managed funds and it is still debatable as to the competence of the fund-managers. You might not be able to beat the market all the time, but even if you could coast along, you are better off.
Delegate Your Risk Across Money Making Assets: You have assets — let’s say residential property, and nothing else. Aren’t you really taking a risk here by investing so much on real-estate when you could have been better off by investing in stocks, bonds and other investment vehicles? If all you had were residential property and in an event of a natural calamity, they would be reduced to rubble and you would be left with nothing.
Asset allocation is defined as the act of allocating your funds into various asset classes to achieve diversification. If you gave yourself enough exposure to equity (stocks and shares), liquid cash, bonds and real-estate, you would have allocated your assets appropriately.
Diversification – Eggs and Baskets Do Matter: Diversification is a rather simply way to minimize risk. However, it doesn’t mean you pick up every random investment vehicle just like that. Depending on your plan mentioned in point 1, you would do well to pick up prudent investment plans and stick with a continuous investment strategy like “Dollar Cost Averaging” to get the best results.
Diversification can be achieved within asset classes too — say in the case of stocks, you could invest in small to large market cap stocks and then within bonds. It can range from company issued bonds to government issued bonds and so on.