You can invest the money you have saved in many ways – today we can choose from a long list of available financial instruments that differ in many respects, m.in. rates of return and risk. But before we start multiplying capital, our first task should be to find an answer to the fundamental question: what type of investor are we?
Understanding investing
You can invest the money you have saved in many ways – today we can choose from a long list of available financial instruments that differ in many respects, m.in. rates of return and risk. But before we start multiplying capital, our first task should be to find an answer to the fundamental question: what type of investor are we?
Why do we invest money at all? For some, it will be the need to maintain the value of money over time, or – to put it simply – to protect it against inflation. For others, it will be a step towards achieving financial freedom, building additional pension security or a way to achieve goals that are generally costly, such as their own apartment. Still others will invest – because they want to build something from scratch or do something good for themselves or the community.
However, let’s focus on investing in financial instruments, i.e. the need to multiply the capital we already have. Contrary to appearances, investing is a strategy written out for years (if not decades), not dreams of quick riches. If the latter scenario is closer to us, then we are probably on the best way to lose all our savings and join the group of people who see investing only as a gamble and a way to quickly zero out our investment account. This is not the approach of investing.
The (ir)rational human being
The propensity to save (how much we save) is the opposite of the tendency to consume (how much we spend). In the economic model of the “rational man”, each of us strives to maximize profits and acts in accordance with his long-term interest. This would mean that we would regularly set aside some of our monthly income for future benefits. In practice, for most of us, setting aside a certain amount every month is associated not only with the need to give up some of our current expenses, but often with a difficult fight with the inner voice that suggests further reasons not to do it. But if we persist in our resolution to save regularly, over time the capital will increase, and we will face a difficult task, what to do with it?
Of course, it is possible that we will be forced to reach for this money due to various random situations. That is why we do not take a zero-one approach to savings, i.e. we do not treat all the funds set aside in the same way. The basic principle is to divide them into several “funds” for different purposes. We treat some of it as capital for a rainy day, i.e. our safety cushion for larger or sudden expenses. Let it be a three-month, or even half-yearly or annual monthly average income. However, we can invest some of them. Let’s mention the “rational man” once again in the context of investing. Taking into account the long-term interest, he will maximize profit or limit risk, i.e. he will choose those financial instruments that give a higher rate of return at the same level of risk or offer less risk at the same level of profitability. Here again, however, it must be said that we do not act rationally on a daily basis, also in the area of investments, making decisions based on hunches and often guided by emotions.
It is also worth clarifying: what does it mean that we are rational people? Nowadays, it is more and more common to find the claim that man is not rational or acts on the basis of limited rationality. Certainly, no one wants to insult us here. Limited rationality means only so much that we make our decisions with incomplete, sometimes even uncertain information. Of course, to this must be added decisions based on emotions and social factors. So what does it mean?
If we want to enter the path of wise and rational decisions related to investing our hard-saved money, we should minimize information restrictions and reject uncertain, untrue or suspicious information. This is why it is important that we obtain true information about the investment instruments and financial institutions that promote us investing. And one of the goals of this article is also to provide you with the right information that will allow you to invest wisely in the modern, very dynamic world of finance. Acquiring knowledge and information will therefore lead to minimizing information limitations, which in turn will result in our investment decisions being optimally rational.
What kind of investor am I?
Every day you follow the latest stock market news, read the business press, browse forums about investing, are on several groups in social networks where investors share their profitable trades, and finally come to the conclusion that it is time for your own adventure with investing. After all, you already know everything about it – at least that’s what you think. And since investing today is easier than ever before – thanks to mobile applications and the Internet, we can buy and sell various financial instruments from anywhere and often at any time – why not try your hand? After all, it only takes a few clicks to feel like a real wolf from Wall Street or Książęca Street. The hypothetical sequence of events described above – let us note – has more to do with financial speculation than long-term value investing.
Therefore, before we move on to investing, it is crucial to determine what kind of investor we are: what we want to achieve, how much time we can devote to what our investment goals are, what our risk acceptance looks like, what our financial situation is. It is worth taking a moment to think about and define your priorities. If a loss, even a small one, of capital is unacceptable to us – a large part of risky instruments will not be for us at the very beginning. If the fear of loss keeps us awake at night, and investing turns into a panic checking of the brokerage account every now and then – it is a sign that risky instruments such as shares or investment funds will not be the solution we are destined for. By answering these few questions at the beginning, we will avoid disappointment and many problems in the future, which we would not have to face if we had honestly assessed our capabilities and approach to risk right away.
The first rule that every investor should remember is one of the most universal laws governing finance: the higher the rate of return, the higher the risk, and vice versa. The higher the risk, the higher the possible rate of return on invested savings.
Each investment product can be described by several attributes, i.e.: liquidity (whether I will be able to exit a given investment quickly if the need arises or at a price acceptable to me), volatility (the range of fluctuations of a number of market prices over time), which allows for the assessment of the risk of a given investment (understood as the standard deviation of return rates on an annual basis up or down), rate of return (how much we are able to earn on an annual basis), entry level (how much capital we need at the beginning of the investment), investment horizon (what is the duration of the investment; in the case of some products, early termination of the investment is associated with, for example, loss of interest or even penalties).
Investing can be learned
By applying the principle of the higher the rate of return, the greater the risk, it is possible to sort out various financial instruments, from those with such a low risk that it is practically ignored (bank deposits, treasury bonds), to those increasingly risky such as corporate bonds, investment funds and the shares themselves. Finally, there will be products that additionally use leverage, such as futures contracts, e.g. for raw materials, currencies or options. On top of that, there are also new, extremely volatile instruments such as cryptocurrencies.
And just as we lose on a deposit only if it is terminated early or when the nominal rate of return is lower than the inflation rate (which in some market conditions can happen periodically), in the case of derivative products, Forex or cryptocurrencies, we can lose all the invested funds in a very short time. So let’s not fall for the high profits promised by sellers, especially if we don’t understand the risks or the fact that we can squander many years of saving in a very short time.
Before we start investing, it is crucial to understand the rules that govern financial markets, how specific investment instruments work, when we make money and when we lose. This will help us plan the entire investment strategy and properly manage the investment portfolio when the market situation changes. Not only the investment goals themselves are important, but also the way to achieve them. Education is key here. This is clearly visible in the case of, for example, investing in alternative investments, such as stamps or coins – without knowledge we are doomed to failure at the very beginning (or we can count on blind chance, but can we rely only on this?). In traditional financial investments, before we decide to buy the first shares or participation units in the fund – let’s also start by gaining the appropriate knowledge. Investing can be learned. The more time we devote to education, even theoretical education, the lower the costs of learning to invest on the basis of trial and error.
Another important rule is not to invest all the money we have in one product, but to diversify (diversify) the portfolio based on predetermined parameters. It can be, for m.in, the selection of such different investment products (e.g. shares, funds, bonds), but also – if we are thinking about building an equity portfolio – investing in companies from different industries, due to their size or markets (e.g. internationally).