Investing offers a way to develop long-term wealth. But investors need to choose from a range of investment alternatives by considering their risk and return prospects including cash, bonds, alternatives such as commercial property and commodities, and stocks.
Most people will understand the importance of making financial provisions for the future and will also have a savings goal in mind - perhaps for retirement, a holiday or just for future emergencies. Then, they may also know how long they have to save - a year, ten years, perhaps longer. There is also the investors temperament to consider - how well they could cope with the possibility of their investment falling in value. With these factors in mind, therefore, an individual should be able to judge how much risk they are willing to take.
Investment risk is like the volume dial on an amplifier – you can turn it up and down as you wish. In theory, the more risk you are able or willing to take, the greater your potential reward. Of course, more risk also means greater potential for loss.
2. Remember the value of dividends
When things are going well and the stock market is rising strongly, the extra return from dividends may be considered as little more than a token gesture. However, in weaker markets the extra return from dividends becomes a valuable part of the total return, especially over time as reinvested dividends are compounded.
3. Recognise the benefits of diversification
Diversification has always been considered the first line of defence in reducing investment risk. This is because spreading your funds across different investments reduces the impact of an unexpected fall in one of them. In effect, it reduces the importance of each single investment decision.
The main asset classes perform differently at different times in the economic cycle.
Trevor Greetham, Fidelity’s asset allocation director, did say in a interview: “Recently there have been no safe havens in the equity world. However, stocks and bonds often move in opposite directions. Commodities dance to their own tune, sometimes moving with stocks, sometimes against. Each time a bull-run in one asset class comes to a halt, leadership passes to another.
“When equities peaked in 2007, commodities surged. When the commodities ran out of steam in mid 2008, government bonds started their charge. When the world economy recovers from its current difficulties, stocks will take up the running once more. A well-diversified portfolio of stocks, bonds, commodities and cash would have performed well over the past 30 years with a low level of volatility.”
4. Be aware of the dangers of trying to time the market
Perfectly timing your investments to coincide with the top and bottom of market cycles is generally not possible. Experts advise long-term investors to remain calm through periods of volatility. For new investors, the challenge is also a question of timing. Many investors experience a nervous wait for what they consider to be the ‘right moment’. Unfortunately, that moment is only clear once it has passed.
The real danger of missing that crucial bottom is that the early part of the recovery is often the strongest. After the dot.com crash, it took 56 months for the US market to fully recover, but half of the total gains were made in the first 16 months.
5. If you are nervous, drip feed your investments
Investors who are nervous about timing their investment can make regular contributions to their asset growth in smaller tranches over a period of time. Regular savers, including those investing into managed funds with regular contributions are set to reap long-term rewards. This can be especially effective when markets are at a turning point.
“Buying the U” describes the process of feeding money slowly into the market while it is still falling, through the bottom and up the other side as the market recovers. Monthly investments offer a way to benefit no matter how the markets are performing: If stock prices go up, the stocks you already own will increase in value. If stock prices go down, your next payment will buy more stocks.
Such an approach can go a little way to eliminate the anxiety of timing large investments, can smooth the highs and lows of the market and even improve an investor’s eventual outcome. The regular investor finishes the period with an investment that is worth more than if the entire amount was invested at the outset, even though the units are the same price at the end of the period as they were at the beginning.
6. Start sooner rather than later
Conventional wisdom suggests it is ‘time in the market’ rather than ‘timing the market’ that is the key to developing long-term wealth. Therefore, starting to invest early is important.
The impact of compounding, which describes the exponential growth that can be achieved by earning interest on previously earned interest - is profound. The earlier you start investing, the longer your assets have to work in the market for you. Starting that strategy today or tomorrow is not too late but failing to act may result in falling short on assets when they’re needed most.