Saving essentially means storing your money; investing means using your money to earn more money. You don’t have to be wealthy to invest. But you have to invest if you ever want to be wealthy, or even have enough money to live well and retire well.
As with saving, when you’re considering investing you first need to set your goals. You need to be clear about what you’re trying to achieve, and how long you’ve got. That will influence the investment decisions you make.
Risk and return
Every investment entails a degree of risk. The larger the potential return on any investment, generally the higher the risk it has. This means the greater the chance of large fluctuations in its value over time – from significant gains to possibly the of loss of some or all of your initial investment.
If your investment is classed as ‘low risk’ it means that its returns will be lower, but the risk is less. However, if the return of the investment is lower than the inflation rate, the buying power of your money will also decrease. So even ‘low risk’ investments carry a significant degree of risk.
Timing is also a risk when you have to sell an investment. The market could be in a downturn, so you won’t get the best price. Similarly, you may sell your investment too early because you have lost confidence in it and then if the market improves you could lose out. Everyone’s tolerance of risk is different, and it will vary depending on your stage in life, as well as your circumstances.
Diversification
If all this information about risks leads you to the conclusion you don’t want to put all your money into the one investment but instead several, then you’ve started to think about diversification.
Diversification is when you divide your investments into different areas to reduce the overall level of risk. Like the truism: ‘Don’t put all your eggs in one basket’, diversification is a fundamental aspect of investing well.
For example, a balanced investment portfolio (a group of investments) can include a range of high risk, moderate risk and low risk investments such as property, shares, managed funds, and other investments.
Timeframes
Imagine that your goal is to travel the world. You want to leave in six months’ time and you haven’t saved nearly enough money yet, so you decide to invest to try and make up some of the difference.
You could punt on high return investments, but as they carry a higher risk, if they fell in value, there may not have enough time to make up the loss. So if you were prudent you would generally choose a lower risk investment with lower returns, or a mix of both high and lower risk investments (with more of the latter), to balance out the risk and returns.
If you planned to travel in three years’ time, you would have the luxury of being able to choose a greater proportion of higher risk investments with higher returns, because you would have more time to make up any temporary falls in their values.
This simple example shows how risk levels and timeframes (the amount of time you hold your investments) are interrelated, and you shouldn’t consider one without the other. Generally, the more investment time you have, the greater the investment risk you can afford to carry, and hence, the higher your returns over time.
Do your research
When you start to look for investments, there are three basic areas that you need to consider:
The amount of time that you have to let your money grow.
The level of risk that each individual investment carries.
How to combine the individual investments in a way that will reduce your risk, yet give the level of return you want. You shouldn’t consider any one investment in isolation, but rather, how each would work with the others in your investment portfolio.
Borrowing to invest
If you don’t have all the money you need for an investment, you may be able to take out a loan from a financial institution. Don’t forget to shop around for the best loan option for your needs, and make sure you’ll be able to manage the repayments. You should seek professional advice before borrowing, and try to have some money in reserve in case things go wrong. Because if your investment doesn’t go the way you planned, or you lose your job, you’ll still need to meet the loan repayments!