Though the concept of investing is simple, the process of implementing it and succeeding is not so simple. This is primarily due to our emotions. Whenever the market falls, fear tempts us to sell and when the market rises, greed tempts us to take more risk.
To keep your emotions in check, it is essential to have a solid investment plan. Here are a few suggestions for writing an investment plan (yes, you should write it down) so that you can refer to it during the investment process.
Objective of investment
Any investment must be chosen with a specific goal in mind. Generally, investments have the following characteristics: safety, income or growth. The first thing you need to decide is which of those three characteristics is most important. Do you need current income to live on in your retirement years, growth so the investments can provide income later, or is safety, i.e., preserving your capital or investment amount your top priority? Here age plays a major role. If you are young and just started your career your investment plan is different than that of a person who is nearing retirement.
Many investment choices / vehicles have minimum investment amounts, so before you draw up your investment plan, determine how much you can invest. Decide whether you can invest in lump sum, or make regular monthly contributions. Many mutual funds permit you to do an investment (under systematic investment plan) as low as `500 per month.
It is always a good idea to go give a standing instruction to your bankers where you have salary / checking account. Investing monthly in this way is called as dollar-cost-averaging which helps to reduce market risk in the long term. If you have a larger sum to invest, more options are available to you. In that case, it is a good idea to invest in variety of asset classes and investment vehicles to minimise risk.
Decide the holding period
In any investment plan, holding period or establishing a time frame for investment and sticking to it is of the utmost importance. If you need the money to buy a car in a year or two, you will create a different investment plan than if you are putting money into a retirement savings plan on a monthly basis for the future. In the first case, your primary concern is safety, i.e., not losing money before the purchase of car. In the second case, you are investing for retirement, and assuming retirement is many years away then your investment should help your account be worth the most by the time you reach retirement age. In general, significant growth typically requires a commitment period of at least five years or more.
How much risk can you bear?
Some investments have a higher level of risk which means that probably you could lose all your money. These investments are too risky for many people. Be cautious about buying only high risk and high return asset. There is no such assets called as high returns with low risk. Better to earn moderate returns than swing for the fences. If you decide to swing, remember, it can backfire, and you can incur big losses.
Where you should invest
Generally, people buy their first investment product as a tax shelter. Better make a list of all investment choices that meet your stated goal. Then take the time to understand the pros and cons of each instrument. Then, narrow down your final investment choices to a few that you feel confident about. To conclude, the key to successful investing is to stick to your investment plan.
The writer is a professor of finance & accounting, IIM Tiruchirappalli