If you're interested in the principles of investing, it is important to understand how much you can invest and which asset classes you should invest in. Uncover some practical steps you can take to start investing.
1. Allocating funds to investing
2. Different investable asset classes
3. Considerations to bear in mind before investing
Your investing budget
You need to understand your personal finances before you start investing. So go over your income sources and outgoings, then decide how much you can afford to save or invest with your leftover income. If you’re not sure, there are plenty of general budgeting “rules” – the 50/30/20 rule, for one recommends using 50% of your net income on essentials like rent, food, and transportation, 30% on your non-essential wants, and putting aside 20% to save, invest or pay down debts.
Your goals and time horizon will affect those proportions, mind you. For example, you might choose to save or invest more if you’re putting money aside for a house deposit. And if you have a longer investment horizon, you might choose to invest rather than save to benefit from the power of compounding. After all, compounding allows you to build wealth by generating earnings from accrued interest and earnings over a long period of time.
You will also need to take stock of your risk appetite – that’s the amount of risk you’re willing to take, and it’ll impact the type of assets you invest in. The answer will depend on your stage of life, attitude towards risk, age, investment goals, and income. As you near retirement, say, your need for income will increase while your risk appetite decreases.
Your asset options
There are thousands of investment opportunities to choose from, and they can be broadly classified into five categories:
When you buy a stock, you’re buying a share of a company. You’ll have plenty to choose from across different markets and sectors, and they are usually driven by internal factors like the firm’s sales, profits, and cash. Bear in mind, though, that stocks in general are highly correlated to economic growth and tend to do well when growth is strong.
Bonds tend to be less risky than stocks, and they’re mainly affected by wider trends like inflation and central bank policy. They represent a part of a loan, issued by governments, corporations, or individuals. They can bring in “fixed income” because the bondholder will receive interest payments over the life of the loan – usually, the higher the risk, the higher the yield.
Cash and currencies
Cash is one of the biggest and most liquid assets. Besides your home currency, you could pick up foreign currencies that you think will appreciate. Currencies are mainly affected by relative interest rates, inflation, growth, and economic policies. In a higher rate and volatile economic environment, investors with lower risk appetites might prefer to hold a bigger proportion of cash in high-interest savings accounts.
Alternative assets are a lot less liquid than traditional assets like stocks, bonds, and cash, meaning they aren’t as easily converted into cash and are less regulated. Think private equity, commodities, real estate, art, wine, and digital assets like crypto. And because their performance isn’t as strongly correlated to the economy or other traditional asset classes, alternatives can help diversify your portfolio. Mind you, their illiquidity means they’re at higher risk, but they tend to compensate with much higher returns.
Your approach to investing
You can generate returns through active or passive investing. Active investors take a hands-on approach in stock selection, and often buy and sell their assets frequently in hopes of generating higher returns. Active investing can be time intensive, but it offers you the potential to generate outsized returns. Unfortunately, historical data shows that very few active funds tend to outperform their benchmark1. Passive investors, on the other hand, tend to have a buy-and-hold strategy and generate market returns by investing in an index. If you’re new to investing and don’t have much time to research your investments, passive investing may suit you more: it’s a more cost-effective and less complicated way of investing.
Considerations to bear in mind
As you start building your investment portfolio, you’ll need to think about diversifying your risks. Make sure your capital isn’t concentrated in one single asset class, or in assets that share the same price drivers. Diversification is important because it helps reduce your portfolio’s overall risk, without necessarily sacrificing your returns. You’ll want to allocate your funds to different asset classes, and how you do that will depend on your goals. If you’re more interested in capital preservation, you might prefer a conservative portfolio with higher allocation toward lower-risk securities like bonds and cash. If capital appreciation is your goal, you might want to weigh your allocation more toward stocks. Your portfolio’s design will ultimately depend on your circumstances, like your stage of life, time horizon, liquidity needs, and risk appetite.
There’s no one right way to invest, and often, the best way to learn is to invest yourself. But here are some general tips: exchange-traded funds (ETFs) can provide a cost-effective way to diversify your capital quickly. Remember, no amount is too small to begin investing, and you should only start with a sum you’re happy to risk. Even if you have a strong investment idea, it’s better to test your thesis out with a small position size – you can then decide to grow it over time. Dollar-cost averaging is a good investment strategy: it involves slowly building a position in an asset by investing the same amount of money at regular intervals. The approach takes out the risks of timing the market and instills discipline around investing. Bear in mind, there are no guaranteed returns in investing, and the best place to start is to assess your personal goals and risk appetite.