‘Risk comes from not knowing what you are doing.’ – Warren Buffett
Investment is a topic rich in flavour. Whatever takes your fancy is possible to become an investment with the right attitude and a little work. I mean that sincerely. Almost anything can become an investment.
I will explain a little about asset allocation. For many, this is a subject just as important as stock picking or any one of a number of other issues. Rather than explain to you what to do, I am going to try and explode a few myths about things you should definitely not do.
Asset Allocation by Dummies
Why say that? Why am I being so mean? Especially to those that know no better? All will be revealed.
I would like you to think about a word for a few moments. That word is:
Risk
What does it mean to you? Especially when related to money it is very important.
If I have had one bizarre conversation about risk with someone who obviously has no clue to the meaning of the word, I have had one hundred of them.
To make it easy, think of risk as this:
The value of your asset might fall quickly at almost any time and never recover the sum you initially invested. The asset might actually become valueless or impossible to sell at any price.
I’m just guessing here, but that might not be how you think of the word risk. If I were to tell that to you just before you bought shares with your life savings, you might want to reconsider. Not many people like that definition.
Yet, that is the reality with many, if not all investments. What needs to happen is for risk to be assessed clearly and thoughtfully and a decision made.
The decision to make is this:
If the asset falls in value unexpectedly, how will it alter my life? If it will have an adverse impact, should I still invest?
For what was the money intended to be used? Will your kids be unable to go to university? Will the mortgage not be repaid? Will you be unable to sleep at night because of the extra stress? Will your retirement be postponed?
Hmmmm. These are some serious questions that probably do not come to mind when you are posting the cheque.
Diversify
Whatever you may be doing in life and with your money, to be a little safer, you might want to consider placing a few eggs into a different basket.
An example for you (of what not to do) is the one company investment plan. This is VERY common in society. By one company, I mean that almost all a persons assets are held under one roof.
For example: you work for a bank, who pay your wages into an account held at your local office, your savings are in a separate account, your pension is with the bank and you receive and own shares in the company through bonus systems and purchase arrangements.
What happens if it goes under? Ask a former Enron employee what happens.
The answer, I’m afraid, is that you lose virtually everything. You lose your job, which makes it hard to pay the mortgage and so your home is at risk, your pension is disappearing and the shares are worth nil.
Another similar occurrence is property. Many buy property as either a developer or landlord to assist their pension planning. As a strategy it is fine. But many of these people buy property because it is ZERO RISK. Who told them that?
Property can be a very risky investment. Here is another scenario for you to think over. You buy, say, five houses in a town. On each one, you use a minimal deposit and take a substantial mortgage. Some time later, things turn bad. The local factory closes, unemployment rates rise steadily and your
properties lose their tenants. This happens across the town and property values start to fall as people sell to move elsewhere to find work. You now have several properties that are standing empty,
mortgages to pay on each one and asset values below the value of the loans.
This will stop you from selling as the bank needs more than the houses are worth. If this economic slowdown is nationwide, interest rates may rise too. This makes the monthly repayments on your mortgages impossible for you to pay alone.
Does this sound potentially risky to you?
I have a number of clients that are nearing retirement, would call themselves low risk who just want a quiet life. And yet, they are the unlucky owners of a technology portfolio bought before the crash. Were technology shares for them? I doubt it very much.
The point of this diatribe is a simple one.
Investment is risky in nature. Before investing, you need to fully appreciate the risks you are taking on and give some thought to their potential impact to your lifestyle.
If you really do not want to understand the risks you are taking on when making an investment, you should spend the money on something nice instead.
Think of it this way; if you lose money in an investment you didn’t understand, you will always feel bitter about it and wish you had not invested. You will probably also not wish to invest again.
However, if you instead, spend the money on a nice family holiday, you will at least have fond memories of the cash!
This isn’t the kind of advice that investment advisers normally dispense, I know, but I’m sure you can see my point. If you are willing to invest just a little time and thought, with the help of a competent adviser you can make money work for you. If not, do you need a new car?
If we can now presume that you want to read on, that you have just spent money on a family holiday, I will explain some basics about low risk investments. I will not even touch on anything considered risky by the mainstream financial industry. I am doing this very deliberately.
Most people seem to take the view that investment should be risky but there are many safe and relatively secure investments available to the average person. The exciting and risky investments should really only be investigated once you have sufficient holdings in safer areas.
Therefore, the following is my top 5 list of things to do if you are starting out in the world of investment…
Pay off any UNSECURED loans
Think of it this way, if you invest money into a collective fund, you will be really pretty happy if the investment returns say, 10% each year (ignoring inflation). 10% might not seem too demanding, but plenty of funds DO NOT achieve this. On the other hand, your store cards or credit card are probably costing you interest at 20% or more each year.
This means that whilst repaying a store card doesn’t actually earn you money, it will save more than it was likely to earn. Your money will be guaranteed to have a positive result. If only all invested money was guaranteed a positive result! Take advantage of it.