Mastering the investment world can take a lifetime, but there are some things you need to know before you even start if you want to have success. There are so many different investments to make, and they all have their pros and cons. Below are some critical points you need to consider before you start to build a portfolio of your own.
The ‘80/20‘ Rule
The ‘80/20’ rule, often referred to as the ‘Pareto Principle’ after the economist Vilfredo Pareto, says that 80% of results come from 20% of the effort. Focusing on the core ideas and measurements of results is one of the first things you should learn about, as understanding these will enable you to move forward with more confidence.
Work Out Your Timescale
You need to establish how long you can leave your investments untouched for. The best returns come from long-term investments and although it is possible to make short-term gains, it is less likely. Long-term investments are more likely to be affected by implied volatility in a positive way. Why? Because there is the advantage of compounding to consider.
Compounding is when the money you have made makes more money for you and it is why people who start investing in early life will have so much more than late starters. A prime example of how compounding works is the S & P 500 index. Taking the period from 1.1.2002 to 31.12.2016 and the average return was 8.76%. Shorten that to a 5-year period starting at the same date and the average return drops to 2.46%. That extra 5 years of compounding made a big difference overall.
Choosing The Right Investments
You need to consider what sort of investments you would like in your portfolio. Long-term investments in stocks are more likely to weather the storms of the ups and downs of the market, but there may well still be periods where they are showing a loss. If that is likely to keep you awake at night, it is best to take a balanced approach and have a diversified portfolio.
Using S & P as the example again, if you had invested $100 in the S & P 500 in 1970 it would have grown to $7771 by the end of 2013. However, if you had split that into two $50 investments in the S & P 500 and the S & P GSCI that $100 would have grown into $9457. Diversifying your portfolio helps to hedge the bets against losses and can help you to make more money.
Balancing Stock And Bonds
If a higher return is what you are after and you are prepared for a higher risk, stocks are the way to go. In the short-term, they can be volatile, but they usually recover if you can afford to leave them long-term.
If you do not want to take a risk with your investments, then bonds are what you should opt for. The return will not be as high, but you will not lose with them. Having a balance of both is what many investors do, but remember that inflation will erode the value of your cash. This can result in the average yield of bonds, which is just 2%, meaning that in real terms you are losing by investing in them.
If you know this stuff, choosing the right investments for you becomes far easier and you are much more likely to have success over the years.