Investing is like marriage, it has to be well thought out before being embarked on. Most marriages end in divorce because they are either rushed into, not well thought out or impulsive. Investing is like building a house, after all, when investing you are building your financial house; it has to be on a solid foundation. When houses are built on solid foundation, they withstand hurricanes of different proportion. In the same way, investments that are made painstakingly, in a well thought out manner like Warren Buffet and the likes do, withstand even the worst financial hurricanes and tsunamis. Against that backdrop, it is necessary that an investor or a potential investor makes sure that his and his family’s basic needs are satisfied. If Abraham Maslow were to be asked, he would most probably say that capital market investing is a higher order need. Most financial planners will tell you that no serious stock investment plan should be started until a potential investor has adequate income to cover living expenses and has a safety net should the unexpected happen.
Get life Insurance It is very baffling to see many investors very deep into the market yet they do not have life insurance. Life insurance is and should be a basic part of any financial plan. Life insurance is a protection for loved ones against financial hardship arising from the death of a breadwinner. This is even more important today than ever before with high cost of funeral expenses, college education and medical bills. So if you are reading this as an investor or a potential investor and you have no life insurance, do first things first, purchase a life insurance.
Prepare for financial Emergencies Life is full of surprises, emergencies do happen, jobs are lost without notices, and even good investment opportunities emerge sometimes suddenly. There is therefore the need for a cash reserve to help weather the financial storms and emergencies when they come calling. Cash reserves do not only provide for emergencies, they also help to ensure that investments are not liquidated prematurely or at inopportune times to cover unexpected expenses. There are no hard and fast rules on what the exact amount of the required cash reserve should be but most financial experts and planners will advise that an amount that equals about six months of living expenses be set aside. A cash reserve should not necessarily be in a savings account or under the mattress; it could be in an interest bearing money market account, money market mutual funds with low to zero luck-up period or another form of very liquid investment that is readily convertible to cash without loss of value.
Know your risk appetite I have heard or read some individuals, in various forums, asking what they should invest in. The answers have, in most cases, never touched on the important considerations in investment as such answers go straight into recommending one bank stock or the other without knowing the investment objective, risk tolerance, age or investment time horizon of the individual that asked the question.
I have also read in the same forums about individuals asking for investment outlets and opportunities that would yield say 30% annual return without any mention of risk. It is a good practice to understand your risk tolerance before you engage in any capital market investment. Your risk tolerance depends on your psychological makeup, your current insurance coverage, presence or absence of cash reserve, family situation, and your age among others. Talking about family situation, it is reasonable to think that a married individual whose children are still in school will be more risk averse than an unmarried person. On the other hand, older people have shorter investment time horizon within which to make up for any losses. the reason for this is because the older you get the less time you have to work to recoup on losses. In that case the risk tolerance of an older man will be less than those for younger folks. Again, the more cash reserve and insurance coverage you have, the more your propensity to take risk. Now having known your risk tolerance based on the underlying factors, you can then define your investment objectives
Set your Investment objectives/goals: Having met those essentials above, you are now ready for a serious investment plan or program. A good investment plan starts with investment objectives. Investment objectives are the force that determines what you invest in. Investment objectives range from capital preservation, to capital appreciation and constant income generation.
Capital preservation as an investment objective implies that you, the investor, aim at minimizing the risk of loss by maintaining the purchasing power of your investment. So if you are risk averse or you will need money from your investment soon for children’s education or for building a house or you are nearing retirement, this should be your objective.
Investors whose aims are to see their investment portfolios increase in real terms over a period of time are better suited for capital appreciation as an objective. This is better for investors that are more risk tolerant and those with more potential to recoup on losses along the way. If you are already retired or nearing retirement, and therefore depend on your retirement plan supplemented by investment income, you need an investment that generates income rather than capital gains. In that case, your investment objective should be current income generation. It is always good to have investment goals stated in terms of risk and returns.
Decide on asset allocation: Armed with the knowledge of your risk appetite and investment objective, you are now ready to decide on what to invest in, and how much to invest in any asset class. This takes you to asset allocation decisions. Asset allocation involves dividing an investment portfolio among different asset classes based on an investor's financial requirements, investment objectives and risk tolerance. A right mix of asset classes in a portfolio provides an investor with the highest probability of meeting his/her investment objectives. Asset allocation is the most important investment decision an investor can make in a portfolio because it demonstrates an investor’s understanding of his or her risk preferences and return expectations.
It is good to strive for a diversified portfolio. Unfortunately the Nigerian market does not provide a lot of asset classes for optimal diversification but diversification can be achieved across sectors or industries within the few asset classes in the Nigerian stock market.
Decide on how to invest: There are different ways to invest in the capital market. You can invest directly by making the stock selections by yourself, thanks to the online stock trading platforms that abound the world over. This implies that you have what it takes to conduct the required research and analysis of the companies whose shares or stocks you wish to buy. It also implies that you have what it takes to know when to sell or add to existing positions. Another method is to have someone "do the heavy lifting" for you. In this case, that someone, often times called fund manager or portfolio manager, does the research and analysis and selects shares that suit your investment preferences, investment objectives, risk tolerance and appetite as well as your investment time horizon. This route is most suitable for investors that lack the knowledge and time for the required research and analysis. If you decide to go this route, mutual funds are the best bet for you.
Get ready for the ride: When you have done the above, then invest and get ready for the ebbs and flow of the market. It may not be easy but if you whether the storm you may be the better for it in the end. Stock market investment calls for courage, steadfastness, wisdom and a smile from the Throne of Grace. Good luck.