One of the biggest mistakes in investing is trying to make as much money as possible. Now, you might read this and think that is the point of investing, but if you believe that, you will likely put yourself on a self-destructive path.
One of the big advantages of using wealth managers over investing your own funds is their training with regard to investment targeting. You own investment style is dictated by what you want to achieve in life. If you are nearing retirement, there’s no point having a high-risk strategy. Similarly, if you are still 25, owning a portfolio full of bonds is not a sensible investment strategy.
Investing according to your knowledge and understanding of financial instruments should be one of the foundations of your investment strategy. If you don’t have the time to conduct rigorous due diligence of equities, there’s no point trying to buy single stocks. At the same time, if you don’t understand the difference between a tracker fund and mutual fund, you should probably stay away from funds and go and do some more research.
The interaction of a portfolio
The most important part of investing is not which investments you choose but understanding how different investments interact with each other and how they will help you reach your long-term goals. For example, you might have stumbled across a stock that you believe can achieve a compound annual return of 25% to 30% for investors for the next 20 years, a once-in-a-lifetime opportunity that shouldn’t be missed. But this opportunity will be entirely wasted if you put all of your funds into it and have to sell the position in two years to meet an unforeseen expense.
Using buckets
The best way to get a handle on your finances and ensure that the above scenario never happens is to use a bucket approach. With this method, you have several investment "buckets" that will vary according to your risk tolerance, position in life and long-term savings goals. A simple strategy would be to put 20% of your wealth in an easy access bank account, a further 20% in a medium-term savings product and the remainder in equity funds.
This is just an example with no particular time frame or savings goal in mind. Different scenarios will demand different buckets. If you’re saving for a house, then risking your savings on the market is not a sensible idea. Over the long term equities generally generate a positive return, but when you find the perfect house there’s no telling where the equity market will be trading. If you have 40% of your wealth saved ready to buy a house, it would be sensible to put this cash in a one-month notice savings account while keeping 20% of your wealth in current cash to meet any unforeseen expenses (this will also make sure that you do not have to dig into your house deposit). The remainder can be devoted to equities.
This approach also gives a psychological advantage. If you have 90% of your wealth invested in equities and little in the way of savings to meet expenses if you lose your job, you become a slave to the market. A fall of 10% in the Standard & Poor's 500 might not be much in the grand scheme of things, but when you have 90% of your wealth tied up in equities, this drop could force you to make wealth-damaging decisions such as selling out at the low to preserve your capital. On the other hand, if you put aside enough cash to provide a substantial cushion, the day-to-day gyrations of the market mean much less and you can look to the long term.
The bottom line
Overall, the key to being a successful investor is not trying to make as much money as possible. Instead, you should seek to invest at a level with which you are comfortable, which will stop you from making silly decisions and give you a much firmer grasp of your finances.
