Key Factors To Consider Before Making An Investment

Before making any investment decisions, it's important to consider your financial situation, goals, and risk tolerance. All investments carry some degree of risk, and it's crucial to understand the potential for loss before committing your money. When deciding how to invest, you should also evaluate your time horizon – are you investing for the short term or the long term? This will impact the types of investments you choose. It's also essential to do your research and understand the vehicles you're putting your money into. There are various investment options available, including stocks, bonds, mutual funds, real estate, and more. Diversification is a key strategy to reduce risk and improve your chances of achieving your investment goals. By investing in different asset classes, sectors, and geographical regions, you can lower your risk of potential losses. Additionally, it's important to consult with a financial professional and seek guidance to make informed decisions.

Understand your risk tolerance and financial goals

Understanding your risk tolerance and financial goals is a crucial step when planning to make an investment. Risk tolerance refers to your ability and willingness to withstand the volatility of the financial markets without making hasty or emotionally driven decisions. It is a personal measure that determines the degree of uncertainty you can handle and the amount of risk you're willing and able to accept. Here are some factors to consider when evaluating your risk tolerance:

• Financial goals: Your short-term and long-term financial goals significantly impact your risk tolerance. For instance, if you're investing for retirement, you may be willing to take on more risk due to a longer investment horizon. Conversely, if your goal is to save for a down payment on a house soon, you may prefer a more conservative approach with lower-risk investments.
• Time horizon: The length of time you plan to hold your investments matters. Generally, a longer time horizon correlates with a higher risk tolerance. This is because you have more time to recover from potential losses caused by market fluctuations.
• Financial situation: Your current financial circumstances, including income, expenses, and savings, play a role in determining your risk tolerance. If you have a stable income and a comfortable emergency fund, you may feel more comfortable taking on higher-risk investments.
• Emotional resilience: Some people are more emotionally resilient to market volatility than others. If market downturns tend to cause you anxiety or panic, you may have a lower risk tolerance.
• Knowledge and experience: Your familiarity with the investment landscape and previous experiences influence your risk tolerance. New investors often start with a more cautious approach, while those with more experience may be open to taking on higher risks.

Once you understand your risk tolerance, you can align your investments accordingly:

• Diversification: Spread your investments across different asset classes, such as stocks, bonds, and real estate. Diversification helps manage risk while pursuing your financial goals.
• Risk-adjusted portfolio: Create a portfolio that matches your risk tolerance. For example, if you are averse to risk, consider a higher allocation of bonds and stable, dividend-paying stocks.
• Regular monitoring: Keep a close eye on your investments and make adjustments as your financial situation or risk tolerance changes.
• Stay informed: Educate yourself about different investment options, market trends, and strategies. This will enable you to make more informed decisions.

Remember, your risk tolerance is unique to you, and it's essential to make investment decisions that align with your personal financial goals and comfort level.

Diversify your investments

Diversifying your investments is a crucial strategy to balance risk and reward. The core idea is to spread your investments across various asset classes, so your exposure to any one type of asset is limited. This approach helps to reduce the volatility of your portfolio over time and lower the chances of significant losses. Here are some essential points to consider when diversifying your investments:

• Stocks and Shares: Stocks represent the most aggressive portion of your portfolio, offering higher growth potential over the long term. However, this comes with greater risk, especially in the short term, as stocks are generally more volatile than other assets. It is recommended to invest in a handful of companies you know and trust, even those whose goods and services you use daily.
• Bonds: Most bonds provide regular interest income and are considered less volatile than stocks. They can act as a cushion against unpredictable stock market fluctuations. If safety is your priority over growth, US Treasury or other high-quality bonds may be a good option. Keep in mind that bonds generally offer lower long-term returns than stocks.
• Short-term Investments: These include money market funds and short-term certificates of deposit (CDs). Money market funds offer stability and easy access to your money but typically provide lower returns than bond funds or individual bonds. While they are considered safer, they may not be insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC).
• International Stocks: Investing in stocks issued by non-US companies can provide exposure to opportunities not offered by US securities. International stocks often perform differently from their US counterparts, so adding some foreign stocks to your portfolio can increase potential returns while also increasing risk.
• Commodity-Focused Funds: Investing in commodities is generally recommended only for the most experienced investors. However, adding equity funds that focus on commodity-intensive industries like oil and gas, mining, and natural resources can provide a hedge against inflation.
• Real Estate Investment Trusts (REITs): REITs invest in commercial or residential properties and provide regular distributions to investors from rental income. They trade on stock exchanges, offering investors instant liquidity.
• Asset Allocation Funds: If you lack the time or expertise to build a diversified portfolio, asset allocation funds can be an effective single-fund strategy. These funds are managed to maintain a specific asset allocation, generate income, or anticipate specific outcomes like inflation.

Remember, diversification does not guarantee profit or protect against losses. Its primary goal is to limit the impact of volatility on your portfolio. A well-diversified portfolio should include a mix of asset classes with low or negative correlations, so if one moves down, the other tends to counteract it.

Choose the right investment account

Choosing the right investment account is a critical step in achieving your financial goals. Here are some key considerations to help you select the most suitable investment account:

Define your financial goals and risk tolerance:

Start by assessing your financial situation, including your assets, debts, income, and expenses. Set specific and realistic goals, such as saving for a dream vacation or your child's education. Consider your risk tolerance—are you comfortable with potential losses, or do you prefer a more conservative approach?

Understand the types of investment accounts:

Investment accounts can be broadly categorised into registered and non-registered accounts. Registered accounts, like RRSPs (Registered Retirement Savings Plans) and TFSAs (Tax-Free Savings Accounts), offer government benefits such as tax advantages. Non-registered accounts, on the other hand, don't offer tax benefits but usually have no limits on deposits.

Evaluate account features and restrictions:

Different investment accounts have varying features and restrictions. For example, retirement accounts like IRAs have specific rules about when and how you can withdraw funds. Consider the level of flexibility you need in accessing your investments.

Compare fees and minimum requirements:

Investment accounts may have account fees, minimum deposit requirements, or other charges. Be sure to review these details to ensure they align with your financial situation and goals.

Choose between self-directed and managed accounts:

You can opt for a self-directed investment account, where you make all the investment decisions yourself. Alternatively, you can choose a professionally managed account, where a wealth manager or robo-advisor handles the investment decisions for you.

Research and compare providers:

Different financial institutions offer various investment accounts with unique features and benefits. Shop around and compare the offerings from banks, brokerages, and other financial services providers to find the best fit for your needs.

Remember, investing involves risk, and there are no guarantees of returns. It's always a good idea to consult with a financial professional to help you navigate the options and make informed decisions based on your specific circumstances.

Select your asset allocation

Asset allocation is a key strategy to balance risk and potential returns over time. It involves spreading your investments across different asset classes, rather than relying on one. This typically includes a mix of stocks, bonds, and cash, tailored to your financial goals, risk tolerance, and time horizon.

Your ideal asset allocation is the mix of investments, from the most aggressive to the safest, that will earn the total return over time that you need. The percentage of your portfolio you devote to each depends on your time frame and risk tolerance.

• Stocks: large-cap, mid-cap, small-cap, international securities, emerging markets
• Bonds: fixed-income securities, treasury bills, municipal bonds
• Cash: money market, short-term debt, treasury bills
• Real estate investment trusts (REITs)
• Alternative investments: hedge funds, private equity, commodities, derivatives, options

When deciding on your asset allocation, it's important to consider your goals, risk tolerance, investment objectives, time horizon, and the amount of money you have to invest.

There are several basic allocation strategies you can choose from, ranging from conservative to very aggressive. A conservative portfolio allocates a large percentage of the total to lower-risk securities such as fixed-income and money market securities, with the main goal of protecting the principal value of your portfolio. On the other hand, a very aggressive portfolio consists almost entirely of stocks, with the goal of strong capital growth over a long time horizon.

You can also modify these model portfolios to suit your own investment needs. For example, you can further divide the equities portion of your portfolio into subclasses of stocks, or adjust the percentage of the portfolio devoted to cash and money market instruments depending on your liquidity and safety needs.

Remember, deciding on your asset allocation is not a one-time decision. You should regularly review and adjust your portfolio to ensure it adapts to your changing financial needs and goals.

Be aware of investment costs

When it comes to investing, there are a multitude of costs and fees to be aware of that can eat into your returns. Here are some key points to consider:

Understand the Different Types of Costs

Common investing costs include expense ratios, market costs, custodian fees, advisory fees, commissions, and loads. For example, mutual funds charge an expense ratio, which is a percentage of the total assets invested in the fund, calculated annually, and paid out of fund assets. There are also annual fees, custodian fees, loads, commissions, brokerage fees, and management fees. Understanding these different types of costs is the first step to minimising their impact.

Research and Ask Questions

The financial world can be complex and confusing, with costs often buried in fine print and jargon. It is important to do careful research and ask plenty of questions to fully understand what you are paying for. The U.S. Securities and Exchange Commission (SEC) has taken steps to protect investors by increasing transparency around fees, so be sure to review their guidance.

Minimise Costs Through Smart Strategies

There are several ways to reduce investment costs, including buying and holding (as trading incurs fees), understanding tax implications, and using tax-exempt or tax-deferred investments. For example, tax-loss harvesting allows you to offset taxable gains with realised losses on investments. Additionally, consider using tax-advantaged accounts like 401(k)s and IRAs, which offer tax benefits.

Be Mindful of Costs When Investing in Property

If you are investing in property, there are numerous costs to be aware of beyond the deposit and loan repayments. These include stamp duty, lenders mortgage insurance, land tax, legal fees, conveyancing fees, depreciation schedules, pest and building inspection reports, mortgage registration fees, insurance, maintenance and repairs, property management fees, council rates, and strata fees. Many of these costs are tax-deductible, so be sure to keep good records.

Choose Low-Cost Investment Options

When selecting investments, consider the costs involved. For example, actively managed funds tend to have higher fees than passive funds, and higher-cost funds don't always deliver stronger performance. Look for low-cost index funds with low expense ratios, and consider using a robo-advisor, which provides automated investment advice at a lower cost.

In summary, investing comes with a variety of costs that can impact your returns. By understanding these costs, doing your research, and making smart choices, you can minimise their impact and maximise your investment gains.

Frequently asked questions