Achieving your goals by weighing the potential risks alongside the prospective returns
Successful investing involves making choices that meet your unique needs today and your financial goals for the future. A well-defined investment strategy is one of the cornerstones of a successful financial life. Investing is about building wealth slowly rather than getting rich overnight.
It’s important to have a solid, dependable core to your portfolio and to consider an equity income strategy where reinvesting dividends compounds your returns over time.
While investment techniques vary widely, all good strategies are built on the same foundation. The principles for investing over the long term require holding a portfolio of investments and weighing the potential risks alongside the prospective returns.
Taking a long-term view
An investor who puts money aside over the long term for the proverbial rainy day is far more likely to achieve their goals than someone looking to ‘time the market’ in search of a quick profit.
The longer you invest, the greater the potential effect of compound performance on the original value of your investment. Many investors will be familiar with the term ‘compounding’ from owning cash savings accounts. The term refers to the process whereby interest on your money is added to the original principal amount and, in turn, earns interest. Over time, compounding can make a significant difference.
Your investments can also benefit from compounding in a similar way if you reinvest any income you receive, although you should remember that the value of stock market investments will fluctuate, causing prices to fall as well as rise, and you may not get back the original amount you invested.
Spreading risk – the importance of diversification
Shares, bonds, property and cash react differently in varying conditions, and opting for more than one asset class can help to ensure your investments won’t all rise or fall in value at the same time. Holding a portfolio of investments with a low level of correlation can help to diversify your investments when investing in individual assets and markets, as well as protecting you from less visible hazards such as inflation risk – the possibility that the value of assets will be adversely affected by an increase in the rate of inflation.
Geographical exposure and long-term investing are other ways of spreading risk. Investing in vehicles such as Open-Ended Investment Companies (OEICs) can remove a lot of the difficulty associated with managing a broad portfolio. It’s important that you aim for a level of risk you are comfortable with which reflects your investment objectives.
Understanding your investments
While a well-constructed portfolio should generate a healthy return for investors, the opposite is also true. It’s easy to incur permanent losses by putting money into an asset that behaves in an unexpected way. Investors should always set aside time to try and understand what it is they want to hold.
Don’t just go with the flow
As we saw to great effect in 2008 following the collapse of US investment bank Lehman Brothers, unexpected or adverse newsflow can have a significant effect on stock market performance. More recently, the crisis in Greece may well present broader opportunities in European stocks for investors willing to take on a certain level of risk. The same goes for China. Indeed, there have been times when highly cash-generative, defensive businesses capable of creating value in a range of market conditions have been subjected to the same negative sentiment that has driven down the price of stocks more sensitive to economic cycles and those that are poorer quality.
Focusing on the real rate of return
Inflation and taxation are factors that can affect the real rate of return on your investment. There are certain options that can reduce costs, including the use of tax-efficient wrappers, namely Individual Savings Accounts (ISAs), pension plans and employment ‘save as you earn’ schemes. There are also inflation-protected instruments, such as index-linked bonds (interest-bearing loans where both the value of the loan and the interest payments are related to a specific price index – often the Retail Prices Index), National Savings investments or commercial property holdings, where rents can often be increased in line with the rate of inflation.