If you are making a list of tasks you should accomplish in 1988, here’s one to add to the list: Establish a well-balanced investment plan that suits your personal financial needs and goals.
Every investor from the newest to the most experienced needs to develop or redefine an investment philosophy. The cornerstone of that philosophy should be a realistic attitude toward risk and return, especially in today’s volatile financial markets. What is your personal comfort level with risk, emotionally and financially?
The first step is to acknowledge your investment objective. Are you investing capital to earn income on which you will live? If so, you should probably choose the most conservative investments unless you are so well off that you can afford to take some risks.
If you are investing capital to realize appreciation for a future purpose, such as retirement, you may want to be more aggressive than an investor for income would be, but how much more depends on a number of factors: Are you single or married with children and other dependents? Are you just beginning your career, heading into your peak earning years or ready for retirement?
Will you need to tap your nest egg in the near future, or can you earmark a portion of your funds for long-term growth? Also important: your financial goals, your family’s tax bracket and, above all, your earning power and investment temperament.
Earning Power. Generally speaking, as your income rises so does your suitability for investments of above-average risk. If, on the other hand, your salary and savings are small but growing – keep risk taking to a bare minimum. Maintain only solid investments for your portfolio. U.S. Government Securities, insured certificates of deposit, high quality corporate or municipal bonds, and high quality common stocks offer you reasonable safety at a steady rate of return and they should form the base of almost every investment portfolio.
If you can count on future income – or a sizable accumulation of assets – to cushion possible investment losses then perhaps you will want to consider opportunities that may carry greater risk, but also offer greater potential for profit. One way to do that is to invest in small companies with superior growth prospects or mutual funds that have a diversified portfolio in such stocks. In addition to income and net worth, measure your future cash needs, such as college tuition bills.
Investment Temperament. Some people are more disposed than others to taking risks, and common sense suggests avoiding investments that leave you feeling uncomfortable. An investment of slightly above-average risk may set one investor’s heart beating with anticipation – and another’s beating even faster with apprehension. One helpful rule of thumb: Never invest in anything if you still feel nervous after investigating all of its pluses and minuses.
Aggressive and timid investors alike can hedge risk by heeding the following five suggestions:
Investigate before you invest. Careful research of potential investments often unearths the small but revealing details that, if nothing else, give you a clear idea of the kind of risk you will be taking. The greatest risk an investor can take is not knowing all the risks.
Don’t put all your eggs in one basket. In a word, diversity. Losses taken on one investment can be offset by gains in another. An experienced financial advisor can suggest ways to hedge risk through diversification.
Set limits, and stick to them. Against their better instincts, investors often hang on to poor pertormers in the hopes they will bounce back given enough time. It takes discipline to set sell limits and stick to them, but in the long run you’ll come out ahead if you do, because you’ll know exactly how much you are risking before you buy.
Monitor investments and the investment climate. Be prepared to adjust your holdings when research indicates it may be time to sell or when your own goals change. Similarly be alert to changes predicted for the general investment environment. If respected market analysts forecast rough weather, consider cutting your risk exposure. Conversely, consider increasing it – in line with your own risk boundaries – when the outlook turns favorable.
Always Match Risk to Reward. This is possibly the most important rule to remember. The riskiest investments should offer the greatest potential for reward. If an investment opportunity gives you the feeling that you are risking too much for too little, move on to others that promise to compensate you more in line with your expectations.
If you start with a well-balanced, long-term investment plan that reflects your personal tolerance for risk, you will be better prepared to ride out rough times and prosper over the long run.