Introduction to Principles of Investing II

We started this series last month focused on managing your wealth. As a quick reminder, to manage your wealth you would need to make investments. Financial investments are key to growing your wealth from whatever level you start. We touched on 2 out of the 6 basic principles that you must know to get you started on your financial investment journey, namely:-

1. Assess your risk appetite
2. Diversify your investments

We will now proceed to look at the other four in today’s article.

1. Determine your Timing

Time is a key component that can affect your investment returns. There are 2 ways in which time affects your investments.

1. a) Time in the Market: Any investment we make may fluctuate in value in the short term and we refer to this as volatility. Such volatility can, however, be smoothed out if you hold the investment over a longer period. A well-managed portfolio of investments, including the different types of investment that we discussed previously, tends to show higher gains over the long term versus the short term.
2. b) Timing the Market: “Buying low and selling high” may sound like a good investing rule-of-thumb. However, if you try to ‘time the market,’ it may lead to risky investment behaviour and result in lower than expected gains or losses to the principal amount invested. It is not simple to time the market by “buying low and selling high.” If you try this, you may end up doing the opposite (that is, buying high and selling low).

Rather, if your investment decision is to simply buy and hold on to an investment over a longer period, you may have the opportunity to receive better investment returns by participating in the market’s best-performing cycles.

2. Use Averaging to your Advantage

Time can serve you in another way when making investment decisions if you utilise the concept of dollar cost averaging. With dollar cost averaging, you are committing to buy a fixed sum of a particular investment on a regular schedule. When prices go up, fewer units will be bought, and when prices go down, more units will be purchased. The cost of each unit acquired can then be averaged out over time.

This is a particularly important principle to follow when investing in financial markets that permit the retail purchase of investments. A regular savings plan in investment securities applies this principle very effectively. In the long run, even if the prices of the securities being purchased increases, you would have benefited from the appreciation in the value of the units already held.

3. Start investing early and re-invest your gains

The power of compounding/compound interest comes into play very strongly for those who can apply this principle. You may potentially maximise your returns by consistently re-investing any gains you receive back into your investment when making your investment decisions. This way, you are continuously putting a larger amount of capital to work, and your investment return will be compounded – and may be maximised – over time. Employed properly, compounding may help you grow a small sum of money into a substantial amount over a longer time horizon.

4. Regularly Review and Re-balance your Portfolio

As part of your process of making your investment decisions, you should keep in mind the evaluation and fine-tuning of your investment portfolio at regularly scheduled reviews (3 to 4 times a year). This evaluation may help to ensure that your portfolio continues to be aligned with your desired risk-return profile and that it is well positioned to achieve your target performance.

Ask yourself if your personal and financial situations have changed, and whether the investment performance of your portfolio has affected your goals. Resist making impulse-driven changes in response to short-term market fluctuations (and incur transaction costs in the process). Keep in mind the investment goal and time horizon you have set for yourself before deciding if there is a real need to re-balance and re-adjust your portfolio investments.

Finally, it is important to emphasise that the professional services of a financial advisor can be most valuable in working through these principles.

*OLUSEGUN OMONIWA is the General Manager for Wealth Management and Affluent in Botswana and Southern Africa (Zambia and Zimbabwe), as well as Acting Head of Consumer, Private & Business Banking for Botswana.