Six tips for investors
New to investing or established but want a quick refresher? Here are six tips to consider when investing.
Work out why
The reason why you are investing can affect the approach you are taking. If you are trying to build up a nest egg to fund retirement, or financial freedom, when you are not dependent on working to enjoy a reasonable income, then you need to apply one type of approach - typically with a long-term time horizon and opting for a high proportion of growth stocks.
If you are retired and have a lump sum, and need an income, then mature companies which pay out substantial dividends may be appropriate.
If you are trying to build up a sum of money to buy a car, or put down a deposit on a house, in say five years’ time, then that requires one approach, if on the other hand the time frame you are targeting is less important - then more risky stocks may be appropriate.
Remember the difference between volatility and risk
There is a general assumption that investing in equities is risky. I don’t agree. If you obey certain rules - more of that in a moment - and have a long-term investing horizon, then equities are not so risky. Equities are, however, more volatile. In the short run, they can rise or fall in value quite rapidly. In the long run, on aggregate, history tells us they outperform most other asset classes. By contrast, in the long run, if you want to avoid the ravages of inflation, cash can be quite risky. If the interest rate minus tax rate is less than inflation, then cash is a guaranteed way to lose money over time.
Don’t use your portfolio as a bank account
Don’t see your investing portfolio as something you can dip into as and when the need arises. Rather, withdraw from it following rules you have set yourself - such as only withdrawing dividends or when your portfolio has reached a certain milestone. There is another way to look at it, sell because you think the timing is right, not because you have to.
Diversify - but really diversify. If you hold lots of stocks, but they all operate in similar sectors, then that is not sufficient diversification. Go for non-correlated stocks too. Some stocks are less sensitive to the economic cycle. Some stocks do well when others struggle, for example commodities and consumer stocks tend to follow different cycles.
Hold some cash - keep some powder dry
Don’t put all of your portfolio in equities, except under certain circumstances. Stocks rise and fall. Occasionally, stock markets see a crash. This happened in 1987, 2000 and 2008. Even if you were unlucky enough to create your portfolio the day before the crash, over time, your portfolio should still have outperformed cash. But the period following a crash can create a real buying opportunity - so some cash can enable you to buy in such times. Set yourself pre-defined rules - for example, buy stock if markets fall by 30 per cent.
Beware endowment bias
Psychologists tell us we tend to put more value on what we own - for example, a ticket to a concert we are interested in may cost £50 and we choose not to buy it because of the price. If we were to win the ticket in a competition and someone offers to buy it off us for £50, we often say ‘no.’ Don’t become a victim of this effect, what psychologists call the endowment effect. Don’t hold on to stocks that you wouldn’t buy if you didn’t already own them.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.