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3 things you need to know before you start investing
There are many different reasons for wanting to start investing. You could be looking to grow your wealth with a specific goal in mind, such as your wedding in a few years’ time or your child’s university education in the medium term. Or you could be building a retirement nest egg to draw on in your golden years.
One common mistake you might make as an investor is getting distracted by the actual investments – stocks, bonds, funds and so much more – without first understanding key investment strategies that could ultimately determine your success.
Just as you need to learn how to drive before being able to choose the right kind of car for your needs, you need to focus on understanding the fundamentals of investing, before you can make an informed decision on the kind of investments that would best suit your needs.
With that in mind, here are several key investment strategies you should learn, to start your exciting and rewarding investing journey on the right foot.
1. Diversification
Simply put, diversification refers to having a wide variety of investments from different asset classes in your portfolio. This limits your exposure to any single asset and, by extension, any particular risks.
An example of a diversification strategy would be to build your portfolio using stocks and bonds from across different sectors or geographies that are not co-related, so if a particular investment experiences a downturn, you wouldn’t have your entire portfolio adversely affected.
For instance, during the Global Financial Crisis in 2008, when stock markets globally underwent a severe correction, U.S. government bonds managed to deliver positive returns. However, the following year, U.S. government bonds underperformed, compared to many other major asset classes and especially in comparison with equity markets.
Unit trusts are one way of achieving diversification in your portfolio, as many of them invest in stocks, bonds and other asset classes, often spreading the investments across sectors and markets as well.
Source: CFA Institute
2. Dollar cost averaging
Dollar cost averaging means you do not try to time the market.
Predicting market booms and busts can be challenging, even for the most seasoned investors. Staying invested over the long term, on the other hand, helps you take the guesswork out of investing and ensures you do not miss out on market upturns. History has shown that missing out on just 10 of the best days over the past 15 years would have resulted in significant differences in the returns of many major global markets.
Cost of missing the 10 best days = $20,964
Missing a few good days of performance can significantly reduce your overall return.
This chart shows how a notional $10,000 investment would have been affected if the 10 best days were missed. We use daily returns of the MSCI North America index in AUD unhedged (Source: Datastream) for the calculations, from 31 Oct 2003 to 03 Jan 2020. Source: Fidelity International.
One way to stay invested is by practising dollar cost averaging. This means you invest a fixed sum of money regularly, regardless of the market conditions. Thus, if prices are low, you would be able to buy more units with the same amount of money, and if prices are higher, you would end up buying fewer.
In this example, if you had invested a lump sum of S$5,000 in January, you would have bought 250 shares at the price of S$20 per share. However, if you had spread your S$5,000 investment into 12 instalments of S$417 per month, you would have ended up buying 300 shares by December at an average price of S$17 per share.
I never have an opinion about the market because it wouldn’t be any good… If we’re right about a business, if we think a business is attractive, it would be very foolish for us to not take action on that because we thought something about what the market was going to do.
- Warren Buffet | Renowned value investor and founder of Berkshire Hathaway
3. Growth vs. Income investing
Another decision you have to make as an investor is whether you prefer taking on more risk to grow your funds in the long term or whether you prioritise receiving regular and stable income in the form of dividends, distributions or interest. It is worth noting, though, that growth and income investing are not mutually exclusive and investors can employ both strategies to their advantage.
Typically, growth investing entails deploying your money into investments that you think are more likely to enjoy long-term capital appreciation. Often, they may be riskier investments in young or disruptive companies, newer industries or emerging markets.
Income investing, on the other hand, involves investments in sectors such as utilities, REITs or non-discretionary consumer products, that generate visible revenue and earnings. They will also have a history of paying out good dividends or being able to consistently increase their dividends to investors over time, but these investments may not necessarily have the same potential for long-term capital growth.
Learning to become a better investor is a lifelong endeavour
Just as you should never stop learning, no matter what your field of endeavour is, you should regard these investment strategies as the beginning of your investing education. There are numerous online resources you can refer to, books you can read, videos you can watch, people you can speak to and events you can attend to become a better investor.
Enjoy the process and never stop learning!
