Before you start investing your money, it’s crucial to chart your course and have a clear vision by answering the following questions:
- What is your investment goal? Are you saving for retirement, future college education, buying a house, a car, or something else?
- What is your time horizon? How long do you have before you’ll need this money?
- On a scale of 1 to 5, what is your tolerance to risk? Keep in mind that higher potential returns often come with higher risk to your investment.
- Given your risk tolerance, what returns do you realistically expect to achieve?
- Do you have enough cash reserves set aside for short-term emergencies, separate from the amount you wish to invest?
- Have you taken steps to protect yourself against unforeseen catastrophic events before you start investing?
- How liquid do you want your investments to be? Consider how easily you can access your money when needed.
- How much can you afford to invest? Will you invest systematically over time, make a lump sum investment, or a combination of both?
Once you have clarity on these questions, you can move on to proper allocation of your funds. Understanding the principles of sound asset diversification is essential to optimize your investments according to your goals, time horizon, and risk profile.
Two basic types of investment asset classes are:
- Fixed Assets: These include investments like Time Deposits, bonds, and fixed annuities. The growth of these assets relies mainly on interest, and their value usually remains stable. However, they often offer lower returns and may not keep up with inflation and taxes, resulting in negative real returns.
- Equity Assets: These are investments in stocks, real estate, forex, gold, mutual funds, etc. Their growth depends on supply and demand factors of the economy, making their value fluctuate. Equity assets historically offer higher returns over the long term compared to fixed assets but come with a higher risk to your principal.
The key to proper asset allocation is finding the right mix of fixed and equity assets in your portfolio based on your needs and risk tolerance. For conservative investors with a shorter time horizon, a portfolio consisting of 60% to 80% fixed assets and 20% to 40% equity assets might be suitable. Conversely, more aggressive investors may lean towards a higher allocation of equity assets.
Understanding the concepts behind these asset types will help you create a well-balanced asset mix that aligns with your financial goals and risk appetite. Remember, investing is a long-term endeavor, and staying informed and patient is essential for successful wealth-building.
