This is the first of a four part series on how to invest your money. The main focus of this series of articles is to discuss the psychology of investing, how to get started, finding your strategy, and building your portfolio. I hope this can be a resource for many people who are looking for information on how to invest their money.
How To Invest Your Money: Psychology Of Investing
When asked how he made his fortune Warren Buffet said, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
Keeping your emotions in check while investing sounds easy enough in theory, but until you’ve witnessed your own investment portfolio gain or lose more than 20% of its value, you won’t know if you have the stomach for it.
While it’s true that the stock market has provided the best returns for long term investors, the returns do not come without risk.
Investment Profile and Risk Tolerance
When you first get started investing you will typically meet with a representative at your financial institution who will get you to fill out an investor profile to determine your risk profile and potential asset allocation strategy.
After determining your age, current net worth, investment knowledge, and main purpose of your portfolio, the questions will turn to your attitude towards risk. Examples of this risk assessment include questions about your willingness to accept losses in your portfolio, and your patience to withstand a market drop and recovery.
After completing the questionnaire, you will receive a score that will correspond to the type of investments that match your profile.
For a low risk tolerance individual, the recommendation will be to invest in GIC’s and other fixed income products.
For a medium risk tolerance, you might be steered towards a balanced growth or monthly income fund. And for the high risk tolerance folks, the advice will be to invest in any number of domestic or foreign equities.
Fear and Emotions
Many people can claim to have a high tolerance for risk when simply filling out a questionnaire. But until your own money is on the line, you just never know how you will react.
Look no further than the most recent market crash in 2008-2009, in which many investors lost up to 50% of their portfolio from the highs in September 2008 to the lows of March 2009. Tuning out the market noise and the negative news headlines is more difficult than it seems.
Fear and emotions can take control of you and even though many people believed they had the stomach to withstand the ups and downs of the market, most did not, and they ended up taking their losses, selling their equities and moving into safer investments like a high interest savings account, or GIC’s and bonds.
Instead of tuning out the noise they succumbed to fear and made an emotional and irrational decision. Now hindsight is 20-20, but the stock market has rebounded over the past two years while GIC’s and high interest savings accounts haven’t been paying more than 2% interest over that time.
If you’re willing to invest your money in the stock market you need to understand the risks involved. The stock market is not for short term savings goals, and it’s not a quick path to riches.
If you can’t handle the thought of losing money during the tough times of a bear market, then you should just stick with savings accounts and GIC’s.
But if you can practice the patience and discipline to stick with your strategy for the long term, and you can ignore all of the market and media noise that can play on your fear and emotions, then you stand a good chance of being a successful investor in the stock market.
In part two of this four part series on how to invest your money I will talk about how to get started with an investment portfolio, depending on your age, current financial situation and future goals.