Before making any investment is essential that you choose an appropriate investment strategy that will help you reach your investment goals.
When you start to plan your investment strategy keep in mind that you cannot avoid the risk, but you can manage it. Like Warren Buffett, the well-known businessman, said - “risk comes from not knowing what you are doing”. This article will help you create an investment strategy, avoiding the most common mistakes.
In one of the studies published by ASX (ASX Investor Study report, 2020), it was highlighted that one of the challenges for investors is the volatility of the markets. Do you wonder how to build your investment strategies to manage your investment risk?
1. Find and Define your Goals
When you make investment decisions you want your savings to grow efficiently, so you should set yourself some goals.
What are your financial goals?
How do you go about setting financial goals?
These are very Important questions!
The objectives are things you decide to do or achieve in a certain period, e.g. you will invest so that your returns are destined to buy a property, studies or luxuries, etc.
Setting financial goals will allow you to get to financial freedom because if you know what you want, you can work on it by charting a path to where you want to go.
2. Understand your risk tolerance
Many people want to invest their money but they do not want to take any risk. In that sense, what they are really looking for is not an investment but an instrument that guarantees an amount in the future.
People usually call the possibility of losing their money "risk". Investment risk can be due to different factors, such as the individual securities' volatility. The good thing is that a part of the risk can be controlled through diversification and an excellent investment strategy.
Risk tolerance is the level of risk an investor is willing to take, and there are three most commonly referenced tolerance levels:
- the aggressive investor who is willing to take high risks in quest of high returns, e.g. crypto investors
- the moderate investor who would only accept a medium level of risk, and
- the conservative investor who is willing to accept lower returns for the safety of their capital. Examples could be investors who prefer cash or term deposit investment instruments.
3. Fundamental Analysis - invest in what you understand.
When we discuss about Fundamental Analysis, we refer to understanding the impact of economic and financial factors on the performance of the company analysed.
If you include Fundamental Analysis in your strategy, it will help you determine the intrinsic value of the company, a 'fair price' compared to the current market price and the company's potential for future growth.
The most important factor in Fundamental Analysis is information about the economy, the industry, and the company itself, that is, any information that can affect the growth and profitability of the company.
Fundamental Analysis can be broken into three distinct parts; the economy, the industry within which the company operates, and the company. ( Raghu Palat, 2016. Fundamental analysis for investors)
"Never invest in a business you cannot understand" – Warren Buffett
After analyzing the company and the political and economic factors, you will have a better understanding so you can invest in what you understand. Suppose you put your money into something you know nothing about. In that case, you may be taking on unknown risks that will lead to unnecessary uncertainties.
It does not mean that you should not invest capital in new market areas. However, keep in mind that what you want is a strategy that helps you incorporate different types of risk.
We have always bet on financial education, conducting research where you can start your investment path. For example, we invite you to review one of our blogs, in which we highlight some podcasts that will help you understand specific investment terminology, or teach you how to research the markets you want to buy in.
4. Sustainable investing.
Sustainable Investing is driven by investors and governments wanting to ensure a "greener" future. There is growing evidence that investors are becoming more' environmentally conscious' in their investments, and firms are becoming increasingly aware of this change. ( OECD,2020)
We have collected some sustainable investing strategies that will help you to make an informative and reliable decision, have a look at the image below.
When we refer to ESG we mean Environmental, Social and Governance. These non-financial factors are increasingly applied by investors when they look at suitable investment alternatives.
Although ESG metrics are not part of mandatory financial reports, companies increasingly include them in their annual or independent sustainability reports.
Ethical investment is focused on investors who want to invest their money in noble causes. For example, if an investor thinks tobacco and alcohol are unhealthy, then this investor will avoid companies that produce tobacco or alcohol.
If you ask yourself, how do you know if the company you are investing in is ethical?
Dedicate time and do a lot of research of the company, because sometimes you will find companies that are supposed to implement ethical practices but could actually disappoint you. You should review the pages of the brand's policy; most companies don't tend to hide these things.
To conclude our sustainability investment strategies, the positive inclusionary requires investment teams to have a clear vision for what kind of changes they wish to affect in society by way of their investment activity.
5. Build your portfolio with an asset allocation strategy.
Asset allocation refers to the mix of investments in a portfolio. It describes the proportion of stocks, bonds, and cash that make up any given portfolio—and maintaining the proper asset allocation is arguably the essential decision long-term investors can make. (Forbes,2020)
These asset classes have different levels of risk and return; for this reason, including investments in several asset classes will help you create a diversified portfolio, reducing investment risk and providing optimal returns.
The most important question is, how do you do asset allocation? It is not an easy thing when you have several investments, each with its own risk and return profile, and you also need to consider the degree of correlations between those investments (that is, how they behave under the markets pressure). Read more in section 6 below.
6. Diversify your investment portfolio.
Each investment carries a risk, therefore the return of the investment will have a certain volatility: it will grow or decrease as the market participants buy or sell into that particular investment.
If an investment is doing well at one time, it does not mean that the same will happen with all of investment at the same time. Similarly, if one investment is doing poorly, not all investments will lose.
For this reason, it is essential that when investing, you consider the concept of diversification. Research shows that diversification is the best alternative to achieve the expected returns and reduce the risk of an entire portfolio of investment.
It is important that you implement the proper diversification of your portfolio in your investment strategy. Just splitting your money between companies in different industries is not enough, you need to go deeper than that and look at how the returns of individual companies behave under daily market conditions - do they react in the same way (a.k.a they are positively correlated), or react in an opposite manner (a.k.a they are negatively correlated).
Technology can help and you should start using tools that help you diversify better. In Diversiview, you will be able to run an analysis of your portfolio, get a high-level allocation diagram and also a detailed (granular) Diversification Diagram.
7. Dolar -Cost Averaging
Dollar-Cost Averaging is an investment strategy that consists of buying assets divided constantly over time, regardless of the market price at that moment.
For long-term investors looking to get better returns thanks to compound interest, it allows them to ride the waves of the market without worrying about its volatility. This strategy implies that there will be times when you will invest when the market is "expensive" and other times when the market is "cheap." This volatility can work in your favor in the long run, as the average of these cheap and expensive purchases will help you grow your portfolio.
8. Regular monitoring
It is not only essential to make investments, but also to monitor them. The financial markets constantly change every time there are political or economic events that can influence the health of your portfolio. For example new laws, financial regulations, even health events like Covid may determine markets to go down.
It is for this reason that it is essential to monitor your portfolio constantly in a few steps:
- Track your performance - you can use platforms such as our partner Sharesight to quickly see how your portfolio performs.
- Check out your portfolio's current position compared with many other potential risk/return positions for your set of securities. As discussed above, the risk and expected return of each security may change in time, so your overall portfolio may change its position - are you happy with the risk you take for the return you expect?
- Review the impact on your asset allocation. Since asset allocation is critical for portfolio risk, have your recent buys and sells transactions changed that allocation much?
Use powerful tools to try different risk and return scenarios and optimize your portfolio, Try Diversiview.
Come at meet us at future events, and ask us everything about Diversiview - the #1 Portfolio Planning and Optimisation Tool that enables investors to design and validate risk-informed, tailored investment portfolios with confidence - before they invest or anytime during their investment journey.
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Disclaimer: LENSELLDiversiview® is a trademark of LENSELL GROUP PTY LTD. LENSELL accepts no responsibility for any claim, loss or damage as a result of using the information on this website. The website content is provided "as is" for information purposes only, it should not be considered financial advice nor solely relied upon for making any trading decisions. Please consult a finance professional before buying or selling any securities or before making any other changes to your portfolio.