There are so many options out there for us to invest our money. Over the last few years there has been a reduction of trading fees, new apps to access the markets, and an increase in social media and online influencing that is driving interest in investing. Not to mention growth in new types of investments like cryptocurrency. Whether it is money that is saved up and needs to be put to work or a 401(k) at your company, what you choose to invest in is a very personal decision. It is important to know some basics to make sure that your investments line up with the goals that you have in mind. Here are 5 things to consider when choosing your investments:
1: Allocate investments based on a plan
Before you put your money in an investment, it is important to define what your goal for that money is. This is the first principle of our investment process at Centered Financial. Your financial plan is a guide that defines what your objectives are for the future. With a plan in place, you should know how much money you need for your goal, how much you need to invest, and what rate of return you should target to reach the goal. Knowing these specifics will help you decide how much risk you are willing to take and what types of investments may be fitted for your goals.
2: Diversify
Diversification is the concept of spreading your money out among different types of investments. There are several ways that you can diversify your money. I recommend 3 basic diversification levels:
Diversification by Asset: This means that you should choose different types of investments for your portfolio overall. Many people will tell you that stocks are the best or real estate is the only place to invest, or crypto is superior to any investment right now. These are examples of different types of assets. Instead of getting caught up in which asset is better, it is smart to choose assets that you understand and that will provide value for your goals. The basic assets are cash, bonds, and stocks, but real estate, crypto, precious metals, and even business ownership can be important pieces of a diversified portfolio.
Diversification by Asset Class: We can divide assets into different classes. Not all stocks are the same. There are large companies, small companies, domestic companies, foreign companies, etc. It is important to diversify among asset classes because each class or market may provide a different opportunity.
Diversification by Characteristics: This ties your investment back to your plan. Some investments are meant to provide income. Some are meant to grow their value significantly; some may provide stability. It is important to understand how each investment will provide value to you. Before you invest, ask: What is the benefit I am seeking? What should I be measuring for success?
Diversification in general is important because it is almost impossible to choose which investment is going to be the best performer or the worst performer in any given year.
Consider the chart below:
This shows various asset class performance in 2018-2019. As you can see, in 2018 all stock asset classes had negative performance. During this year, money that was allocated to bonds (fixed income) and cash had the best performance. However, if an investor moved all of her money to bonds and cash and left it there, she would have missed out on double digit returns in stocks the following year. This shows how difficult it can be to invest. As investors, we can get emotional when our investments are down big or are being outperformed by other investments. We can be tempted to pull out of our strategy and miss out on the long-term results. Diversification gives us a process to manage risk and capture returns of various low or non-correlated assets over time.
3: Know your risks
Not all risks are the same and not all risks may matter for you. For example, someone who needs to withdraw their money for a down payment on a home in 2 months should probably avoid the risk of loss that comes with investing in stocks. However, someone who is saving for retirement should probably be aware of the risk of inflation and avoid keeping their money in cash.
High risk assets like stocks, real estate, business ownership, etc. typically provider higher returns over time which make these investments superior for financial goals that need our money to grow significantly over the long-term.
Less risky assets like bonds and cash are also an important piece of a portfolio because they can provide safety and stability in times when our risk assets are wavering.
To diversify your portfolio, I recommend starting with the basic asset classes above. First, determine how much of your portfolio should be allocated to each box and then invest in the various asset classes. The time to reach your goal is just a general guideline, but I recommend having at least a 5-year time horizon for any investment in the higher risk category. Also, real estate, crypto, metals, and speculative investments all fall into the High-Risk Asset box.
I recommend evaluating your risk often and only take as much risk as is necessary to reach your goals.
4: Understand your investments
The respected investor, Warren Buffett, once said, “Never invest in a business you cannot understand.” I feel this is good advice. If you don’t know how a company is earning money and building value, then it is unwise to put your money into it.
Make sure to do your research. There is a lot of data that you can find at your financial institution to help you understand your investments.
Most of us are invested in funds to gain exposure to the market. Even within funds it is important to understand some basics. You should know the fund’s objective, the target allocation of the fund, and its top holdings.
5: Invest with Purpose
Our slogan at Centered Financial is Invest with Purpose. We feel that your investment process should be deliberate and focused on your individual goals. Your investments should also align with your overall outlook and vision of life.
We feel that it is important to be educated and be involved in the investment process. You should always know what you own and why you own it.
There are may ways that you can put the concepts that I have mentioned to work. With mutual funds, ETFs, automated portfolios, and adviser-managed accounts, the process of choosing investments is very streamlined. However, it is always important for you as the investor to be involved in the process and review your investments regularly to make sure they still align with your purpose.
Need to discuss your investments? We are always happy to chat and answer questions. You can schedule a call here.
Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.