Determining Where You Will Invest

Santri Alat - Determining Where You Will Invest - There are several different types of investments, and there are many factors in determining where you should invest your funds.

Of course, determining where you will invest begins with researching the various available types of investments, determining your risk tolerance, and determining your investment style – along with your financial goals. 

If you were going to purchase a new car, you would do quite a bit of research before making a final decision and a purchase. You would never consider purchasing a car that you had not fully looked over and taken for a test drive. Investing works much the same way.

You will of course learn as much about the investment as possible, and you would want to see how past investors have done as well. It’s common sense!

Learning about the stock market and investments takes a lot of time… but it is time well spent. There are numerous books and websites on the topic, and you can even take college level courses on the topic  which is what stock brokers do. With access to the Internet, you can actually play the stock market – with fake money – to get a feel for how it works.

You can make pretend investments, and see how they do. Do a search with any search engine for ‘Stock Market Games’ or ‘Stock Market Simulations.’ This is a great way to start learning about investing in the stock market.

Other types of investments – outside of the stock market – do not have simulators. You must learn about those types of investments the hard way – by reading.

As a potential investor, you should read anything you can get your hands on about investing…but start with the beginning investment books and websites first. Otherwise, you will quickly find that you are lost.

We’ll follow this rule and focus on the core ideas and measurements that represent the majority of sound investment practices.

Know Your Timeline

You need to commit to a period of time during which you will leave those investments untouched. A reasonable rate of return can be expected only with a long-term horizon.

When investments have a long time to appreciate, they’re more likely to weather the inevitable ups and downs of the equities market.

It may be possible to generate a return in the short term, but it's not probable. As legendary investor Warren Buffett says, “you can't produce a baby in one month by getting nine women pregnant.”

The Magic of Compounding

Another important reason to leave your investments untouched for several years is to take advantage of compounding. 

When people cite “the snowball effect,” they’re talking about the power of compounding. When you start earning money on the money your investments have already earned, you’re experiencing compound growth.

This is why people who start the investing game earlier in life can vastly outperform late starters. They get the benefit of compounding growth over a longer period of time.

Choose the Right Asset Classes

Asset allocation means putting your investment capital into several types of investments, each representing a percentage of the whole. Allocating assets into different classes that are not highly correlated in their price action can be a highly effective way of diversifying risk.

For example, you might put half your money in stocks and the other half in bonds. If you want to diversify your portfolio further, you might expand beyond those two classes and include real estate investment trusts (REITs), commodities, forex, or international stocks.

To know the right allocation strategy for you, you need to understand your tolerance for risk. If temporary losses keep you awake at night, concentrate on lower-risk options like bonds. If you can weather setbacks in the pursuit of aggressive long-term growth, go for stocks.

Neither is an all-or-nothing decision. Even the most cautious investor should mix in a few blue-chip stocks or a stock index fund, knowing that those safe bonds will offset any losses. And even the most fearless investor should add some bonds to cushion a precipitous drop.

The Rewards of Diversification

Choosing among various asset classes doesn't just manage risk. Greater rewards come from diversification.

Nobel Prize-winning economist Harry Markowitz referred to this reward as “the only free lunch in finance.” You will earn more if you diversify your portfolio.

Here’s an example of what Markowitz meant: An investment of $100 in the S&P 500 in 1970 would have grown to $7,771 by the close of 2013. Investing the same amount over the same period in commodities (such as the benchmark S&P GSCI Index) would have made your money grow to $4,829.

Now, imagine you adopt both strategies. If you had invested $50 in the S&P 500 and the other $50 in the S&P GSCI, your total investment would have grown to $9,457 over the same period. This means your return would have surpassed the S&P 500-only portfolio by 20% and be almost double that of the S&P GSCI performance.

Finally, speak with a financial planner. Tell them your goals, and ask them for their suggestions – this is what they do! A good financial planner can easily help you determine where to invest your funds, and help you set up a plan to reach all of your financial goals. Many will even teach you about investing along the way – make sure you pay attention to what they are telling you!