Resolving to spend less and begin investing is admirable, even more so if you decide to do these things at a young age. To ensure you end up with the right portfolio for your needs however, all new investors (and even those who are more experienced) should give serious — and regular — consideration to the following four questions.
What’s my goal?
If you don’t know why you’re investing, it will be harder for you to decide what you should be buying for your portfolio. It may also be harder to stay motivated, particularly during market downturns.
Perhaps you’re saving for a house deposit, looking for a way to fund your child’s university tuition fees or building a pot of money for your retirement. You may want to work less and draw on some of the income provided by your investments instead. So long as this goal is both realistic and relevant to you, we can move on.
What is my target return?
Once a goal has been identified, you need to know how much money you’ll need to realise it.
Let’s return to the examples given above. According to Nationwide, the average UK house price in 2016 was almost £206,000. A typical 20% deposit will therefore be £41,200. With tuition fees now at £9,250 per year, you’re looking at almost £28,000 to fund a three-year degree course. If you’re wanting a retirement income of £20,000 a year, you’ll need a pension pot of £400,000 if you plan on living for another 20 years after quitting work.
Clearly, these values will change. House prices fluctuate; tuition fees and living costs will rise over time. Nevertheless, they give you an idea of the challenge that awaits you.
What’s my time horizon?
This is all about considering how long you have to grow your capital, from the moment you begin investing until you reach your final goal. If you’ve recently had a baby and wish to save for his or her time at university, for example, you have roughly 18 years to do so. Those saving for a house deposit may be looking to invest over a much shorter time period, of course.
Again, you must be realistic here. While shares provide a better return over the long term compared to bonds and cash, their performance over a few years can be far more volatile. If you’ll need it back within five years, the stock market may not be the best home for your money.
What’s my appetite for risk?
Ascertaining your tolerance to risk is key if you’re going to pick the right investments to hit your target return over your estimated time period.
Clearly, someone looking to make a significant amount of money from the stock market over a relatively short time period will need to take on more risk and gravitate towards the lower end of the market spectrum. Those who are more risk-averse should stick to blue chip companies, while appreciating their share prices can also drop on bad news or general market jitters.
As mentioned at the outset, it’s a great idea to start investing at a young age since this allows a person to take on more risk for the possibility of higher returns. Even if some of their investments don’t work out, they should have sufficient time to make amends — a luxury some won’t have.
