22 Jul 3 Steps to Investing

Investment and saving are two common terms in the personal finance world. It is important to get the difference between the terms before going to the first step of investing.

In a simple sense, investment is the commitment of an amount of funds to an investment plan with the hope that the amount will grow in value with time. Savings is basically setting aside some money after paying for expenses. When saving, one is more concerned with the safety of the money while in investment; growth of the committed fund is the key concern.

Below are the three steps of investing:

1. Preparing to invest

Becoming an investor is not just about having money. Successful investors have a common characteristic of having an investor spirit. In preparation for investment, an individual must develop this spirit.

Discipline is one fundamental trait of an investor. The individual must develop a habit of regular saving. They should set intervals at which to save and invest a specific amount. The individual must live within his means to ensure that there is enough money for investment.

2. Setting investment objectives

There are three investment objectives: safety, returns, and liquidity. Every investor would like an investment that is absolutely safe, generates high returns and provides a high level of liquidity. However, that would only happen in an ideal world.

It is very difficult to maximize all the three objectives at the same time. An individual must decide which objective to prioritize. For example, if an investor wants high returns, he/she may have to bear with high risks (lower safety).

When setting investment objectives, individuals should focus on their needs. This involves preparing a statement of financial goals and adjusting it as financial needs change.

3. Asset allocation and investment portfolio management

Asset allocation is the determination of assets like such as cash, bonds, stocks, real estate, etc. and the percentage of each asset in a portfolio. It is aimed at balancing risk and return to ensure that the portfolio meets the investor’s goals, risk tolerance, and time frame. Perfect asset allocation is one which fits the investor’s profile.

Investor’s age is one of the factors to consider when choosing which instrument to include in a portfolio. Younger investors are better off including stocks with great growth potential in their profile. Older investors should prefer a portfolio with a greater percentage of fixed-income products such as bonds to one with risky instruments.

Risk tolerance is the other factor in asset allocation. Risk-seekers prefer high risk and high return assets. Risk-averse investors prefer low-risk instruments while risk-neutral individuals prefer moderate risk when determining the amount to allocate to assets in the portfolio.

In this step, the investor or his/her investment manager constantly manages the portfolio and adjusts the asset classes based on the needs of the investor.

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