Wise Investing: Snoozing Without Losing

Making your money work for you sounds great, but when it comes down to the details of it, things start to get a bit hazy. Investing is one of the few things that people should start thinking about at a really young age. Investing is a lifestyle skill rather than a financial skill. Unfortunately, these skills aren’t taught in school.

With people losing huge amounts of money, through financial professionals who abuse their positions, investment has become a scary idea. For instance, many are convinced of guaranteed investment by financial companies, but the reality is that if the company goes bankrupt, then your money disappears with them too. Honestly, I have very negative feelings when I hear of financial professionals using their professionalism and skill to abuse retail investors, who are the majority of the population and often don’t know the ins and outs of the financial markets.

“Saving is a lifelong activity, and investing is an integral part of it.”

Yet, at the same time, everyone knows that just keeping your money in the bank often depreciates its value by giving you a negative return when adjusted for inflation, so people are still keen on investing. So, I’m passionate about equipping every individual with the right tools and knowledge to invest better.

So how do you even begin to make smart investments? You need to know your investment profile – your risk appetite, return needs and how to start saving your funds to invest.

Assess Your Risk Appetite

Before you can start investing, you need to plan your investments around your risk appetite. Risk appetite is an important psychological factor that many tend to overlook. A lot of people often tend to over-exaggerate the risk that they are ready to accept while concurrently overestimating the potential returns of investments. This ultimately means that those individuals are making riskier decisions with lower returns which can potentially lead to a situation they can’t psychologically deal with. So first, you need to assess your true risk appetite.

Ask yourself what kind of drawdowns you are comfortable with. For instance, if your portfolio drops by 10% or 20% tomorrow, are you okay with that? If you are then it means you have a high risk appetite, if not then you need to know what is a number you are comfortable with so that you know which types of investments to look into.

Investment risk is generally defined as the degree of potential financial loss inherent in an investment decision. Ask yourself what kind of loss are you willing to have on your portfolio? Can you stomach the loss and not be depressed about it? After the loss, do you have the energy to stand back up and continue investing again? Would you prefer the additional peace of mind that comes with steadily growing your money with a percentage that’s just slightly higher than what the banks offer you? Or would you lose interest with such a slow-paced investment approach?

As a rule of thumb, if an investor can accept above 30% drawdown on a portfolio within a year, I consider him or her to have a very high risk appetite, 20-30% would be a high risk, 10-20% a moderate risk and anything below 10% as a conservative to moderate.

As you assess your risk appetite, you also need to know what your purpose for investing is. Psychology is an integral part of investing, and if you don't know your reason for investing, your investment portfolio can’t be structured to suit your goals. What exactly are you saving for and why?

Also, it is useful to reflect on your investment biases. Do you have any particular investment thematic that appeals to you? For example, you might favour biotechnology because you personally want to see such businesses take off. Is your bias empowering or limiting for you?

Start assessing yourself realistically and note down your thresholds.

Evaluate Your Return Needs

After you’ve assessed your risk appetite, you need to know what kind of realistic returns you’re looking for and how fast you expect them.

Your return objective has to be compatible with the risk level of the investment portfolio. For example, if you’re looking for around a 30% to 40% return within a year because you want to grow your finances fast, then you often must accept a proportional risk profile for your investments (which is very high risk). With a lower risk investment, you are likely to miss your goals and lose patience. To get high returns quickly, you would instead need to look at riskier investments like derivatives and FOREX, but those can result in a loss of 100% of your invested capital. So, if your risk appetite is high enough and you can stomach such losses, then that’s fine, but if not then you might have to deal with the unintended consequences. The goal of achieving high returns with a low risk portfolio, while ideal, is difficult to achieve. Investors are usually compensated with higher potential returns for additional risks that they are willing to undertake. You have to ask yourself if there might there be a mismatch between your expected returns and your risk profile.