Are you ready to start making your hard-earned money grow through investing? If so, you should know that investing is more than just knowing your investment options. It has a lot to do with your goals, priorities, and attitudes.
After you finish reading this article, you should understand:
- Your emotional and practical approach to money and investing
- The commitment level you intend to give to your investment strategy
- What investment options may be suitable for you
- Whether you need to team with a financial professional
Active or Passive Investing
Time is a crucial component in your investment decision-making. It helps determine whether you are going to be an active investor or a passive investor. If your investment strategy focuses on long-term gains, both investment methods are effective to varying degrees.
If you become an active investor, you must commit the time to research your investment targets and self-manage your portfolio through an online broker. So, the primary resources required to be an active investor include:
- Time: To offset the higher risks of self-investing, active investors spend a lot of time doing their due diligence on investment prospects and keeping track of purchased securities.
- Know-how: You must have the ability to analyze the industry sectors you invest in, read financial statements, and understand valuations and rates of return. For stocks, you need to understand technical and fundamental analysis.
- Motivation: You must possess the self-discipline to spend many hours on your investment activities.
If you charged yourself a per-hour rate for your labor, it could add up to a substantial sum over 10 or 20 years. As a result, an active investor may earn higher gains than a passive investor for an extended period. However, if an active investor subtracts labor hours from the net total, the profit gap between the two investment styles may not be as much.
Passive investors allow others to do the heavy lifting so they can spend their time on other projects and activities. Some even allow investment professionals to make buying and selling decisions. As a result, they can get good returns without committing to research and portfolio management hours, provided they team up with a reputable financial advisor or broker.
Determining Your Risk Tolerance
Whether you decide to be an active or passive investor, your investment strategy relies heavily on your risk tolerance levels. Higher returns generally come with higher risks. So, your task is to find the sweet spot between the level of returns you want and the level of risk you are willing to assume. As a guide, here are three types of investors according to risk tolerance.
- Risk averse: Since risk correlates with volatility, risk-averse investors prefer low-risk investments due to their stability, safety, and predictability. They will sacrifice the possibility of high profits in exchange for modest gains with an almost zero chance of loss.
- Risk neutral: Risk-neutral investors disregard risk in making investment decisions. They typically focus on situations, current or potential happenings, and opportunities.
- Risk seeking: Risk-seeking investors will purchase highly speculative and volatile investments in exchange for the possibility of very high returns. The high probability of totally losing their money does not phase or deter them.
You should be able to find your risk tolerance level from one of these three investor types or somewhere in between.
What Are the Best Types of Investments?
Although there are many traditional and alternative types of investments, the four best investments for your portfolio strategy are bonds, stocks, index funds, and exchange-traded funds (ETFs).
Bonds are debt contracts that companies and governments sell to investors in return for a guarantee to pay back the principal plus interest (5 percent to 6 percent) to the investor by a specified future date. If you are a risk-averse investor, bonds should appeal to you because the borrowers must pay back the bondholders before the stockholders, even in bankruptcy cases.
When you buy a stock, you purchase a portion of ownership of the issuing company. So, the return on your stock investments depends on the success of the company. Stocks are available in a wide range of volatility and risk levels.
Index funds track a market index like the Standard & Poor’s 500. Historically, the average rate of return on these funds is around 10 percent, and they are great for balancing out your portfolio.
ETFs also track market indexes, but you can trade them with the ease of stocks. In addition, your ETF investment may yield lump sum dividend payments or reinvestments from the stocks in the index.
What Investments Should You Include in Your Investment Strategy?
Your investment choices are entirely up to you. It all depends on the intel you or your financial advisors collect, the amount of money you want to commit, and your risk tolerance level. From what you have learned, you can earn 6 percent to 10 percent on relatively safe and predictable investments like bonds and index funds. However, if you are an active investor, you most likely want much more for your precious time than the modest returns from bonds and funds. Therefore, you would likely prefer investing in instruments like growth stocks and initial public offerings.
Your Investment Strategy’s Role in Your Life
Once you have done some soul searching and self-analysis, you can determine whether you want to be active or passive in your investment strategy. Just remember that time is not redeemable. So, be sure to consider this fact as you develop your financial strategy.