People sometimes ask me ‘where is the best place to invest my money‘. My answer is almost always ‘it depends…‘ (you should see the disappointment on their faces)
For most of us, investing is a natural turnoff; causing us to bury our heads in the sand like an ostrich, especially when financial types speak ‘ gobbledegooky’ language which for most mortals is excessively hard to understand. A few of us do get (over)excited at the prospects of investing our hard-earned money in hope of ‘better’ returns but without understanding the basics of investments, far too many have got our fingers burnt.
So in the series, we are going to look at a few investment concepts that underlay successful investing:
A = Asset Allocation: This refers to how you spread your money across the different asset classes. The 4 main asset classes are: Cash, Bonds, Property and Equities/Shares, although there are subclasses within each asset class.
Asset allocation is one of the most important decisions you will make about your investments; it accounts for well over 90% of the return (or lack of it) in your portfolio. Most people pay little attention to this, rather they are looking for the ‘hottest shares’ (stock selection) or waiting for the ‘best time to invest’ (market-timing), both of which, almost always fail.
Here are some simplified hypothetical examples showing various asset allocations.
Clearly, these portfolios will perform differently at different times, not because one is ‘good’ or ‘bad’ but because they are… …simply different.
So what is the right mix? It depends… … on your goals, how long you are investing for and what level of risk you are prepared and able to take.
B = ‘Buy-to-hold’: This concept refers to the idea of investing money for the longer term as against regular trading (buying and selling on a regular basis in other to seek short term).
There are reasons why buy-to-hold makes sense for most people: one, it is extremely difficult for anyone to beat the market on a consistent basis and two the cost you incur in the process of trading probably outweighs the gains anyway.
Off course it is sensible to review your investments periodically, rebalance and make changes when necessary but this is completely different from chopping and changing your investments ever so often because you think something else is going to perform better.
C = Compound Interest: Simply put, compounding is what happens when your get interest on your interest! Let say invest £1000 @ 6%pa, at the end of the year you get £1060 but if, rather than taking out your interest out, you reinvest it for another year, you not only get interest on the £1000, you also get interest on your £60. This continues on and on and on…
Compounding is the engine that powers long-term investment returns and the longer you are investing for, the more important compounding interest is.
Got it? Personally, I think no one should be allowed to graduate high school unless they can explain compound interest to their classmates; yes it is that important!