The economy has been shaky at the very best, and costs of living have been rising. It is estimated that the retirement savings of many Americans are insufficient to cover their post-retirement expenses. The factors contributing to this fact are largely due to the fears regarding a future recession and job prospects as well as inflation eroding value of the dollar.
In light of this information, individuals are flocking towards investing their savings in riskier securities to bank a higher yield than provided by a T-Bill. Investors in any market need to arm themselves with vital information and understanding of their finances before venturing into investing and committing their life-savings into a risky vehicles and assets.
Rule 1: Risk and Return Are Directly Proportional
This is the mantra every investor should repeat and memorize. The lower the risk, the lower the return; the higher the risk, the higher the yield is likely to be. This is the number one golden rule for every new investor to learn. Government-issued securities and debt by companies rated AAA and AA by relevant rating agencies are considered to be safe. As a result, they offer a return slightly above the risk-free rate as risk premium, to compensate for the additional risk. On the other hand, companies or securities rated fair or junk are far more likely to default, and thus have to offer a higher rate of return to attract investors.
Rule 2: Analyze Your Risk Tolerance
Before investing in any of the available asset classes, it is of utmost importance to analyze your risk appetite. Investing agencies and fund managers offer various tests to evaluate your ability (mental and financial) to undertake risks. Also, age factors into this equation as well. Typically, the rule of thumb is that the younger a person is, the higher risk he is able to afford, for he has a long time period to hold his investment should things go wrong. Vice versa, the nearer a person is to his retirement, the more crucial it is to invest in safer investment avenues.
Rule 3: Don’t Put All Your Eggs in One Basket
That’s right. Diversification is key to becoming a successful investor; the technique to maximizing your returns and minimizing your risk. By diversifying you are in effect reducing your exposure to fluctuations in asset prices and returns that may arise due to any event. To diversify your investment, choose asset classes across categories, industries and countries to achieve an ideal mix of risk and return. Over the long term diversification is the best route to take to secure your investment. Think about it as if it is an elevator: Would you feel safer riding it if it was hung by one cord or several?
Rule 4: Buy Low, Sell High
Once you have invested some of your earnings, remember to balance or update your portfolio once a year. Research and buy assets that are expected to grow and are trading on the lower side of their intrinsic value. Similarly, assets that have performed well, but are overvalued according to their intrinsic value, should be sold. This is because the free markets always achieve equilibrium and undervalued assets are expected to appreciate, while assets valued above their actual worth will depreciate in price.