You can lose money from investing. This is a fact which many seasoned investors may have forgotten while other newbie investors are afraid of. New investors are afraid of venturing into the stock market due to the many horror stories they have heard from other people. Others have burnt their fingers and it affected their confidence so much that they would not dare to invest again.
Why is it that some investors can make money while others lose money?
The differentiating factor of a good investor vs a poor investor lies in a financial plan. A good investor knows what he is doing and is aware of the risks involved. A poor investor mostly follow tips and is not aware of what is actually happening apart from the stock prices going up and down.
A good investor can buy a stock and see a decline of 30% but still make money in his overall portfolio. A poor investor who follows exactly what the good investor buys can still lose money even though the good investor makes tons of money later. Are you the good investor or the poor investor?
Before you start investing
The financial plan should come in way before you start investing. This is not about planning your life to the extent that it becomes boring and mundane but is more about making the financial plan as automatic as possible so you could live your life normally without your finances being in a mess. You don't have to track your expenses everyday for those who don't like it. The financial plan can be reviewed as little as once a year or 2 times a year.
Credit: commons.wikimedia.org
Let's move on to the four steps of a financial plan:
1. Know how much money you want by what age.
To be rich, you got to want to be rich. I've listened to a lot of motivational speakers talk about visualising your dream and so on and I have to tell you this concept really works. What do you see of yourself in 5, 10, 15 or even 30 years from now? Of course you don't have to just focus on money alone as life is not just about money. It works the same for your relationships. Do you visualise yourself to have a happy family? There are so many other things in life. Money is a part of it. Visualise yourself having 100K before the age of 30? Set it as a target and it will happen.
2. Allocate your income into different parts of your life
This is the main part of the financial plan. It may seem like a daunting task in the beginning but trust me, it gets easier over time once everything is in place. The first step is to work backwards and know much much you need to save a month to achieve your goals you set in point 1. If you want to achieve 100k in 5 years time, you need to save 20k a year which is $1666.66 a month. This gives you an idea of how you are going to achieve that goal.
Now, many of you may start to think saving 20k a year is impossible. This impossibility is actually the first step to financial success. Once you have this mindset, turn it around and ask yourself how you can achieve that 20k a year? You'll be surprised that with just a simple change of mindset, you'll start to have ideas coming in to help you achieve that goal. That is how our brain works.
Balance your life between spending and saving. Allocate some money for networking, improving yourself through books, courses, travelling, investing etc. You may have read about an article where Li Ka Shing, a successful entrepreneur in Hong Kong, talks about allocating your money into 5 separate set of funds.
First for living expenses, second for making friends, third for learning, fourth for overseas holiday and fifth for investment. This may be something to consider. Allocating your income into different funds don't have to be done manually every month. I've written an article previously to explain how you can do it automatically here.
3. Protect yourself
Protection comes before investing. It is the base of a financial plan. You've probably heard about the need for an emergency fund. This is the money you set aside for emergency use such as if you lose your job or for sudden medical expenses etc. Some people say 6 months of your income is enough, Other say you need at least 1 year. No right or wrong here. You have to decide.
The next part is insurance. Cover yourself in the event of death, critical illness and also be covered for hospitalisation expenses as this can come up to quite a big sum of money. Some may add in disability income insurance which provides income for you in the event you become disabled and cannot continue working. Some may also add in personal accident insurance.
Insurance is important but don't allocate too much of your money for insurance that you have problems paying the premiums later on. For me personally, separating insurance from investing or savings and it'll be fine.
4. Practice asset allocation in your investments
Now, back to the story of the good investor and the poor investor. A poor investor loses money from investing because he doesn't understand how to create a financial plan. He sees other people make money from the stock market and jumps right into it. A good investor will buy stock A using 5% of his money while a poor investor may use 50% of his money to buy the same stock A.
When stock A drops, the good investor may continue buying stock A at a lower price using an additional 5% of his money. A poor investor may also continue to buy stock A using the rest of the 50% of his money at the same time. When stock A goes bankrupt, the poor investor loses all his money while the good investor loses only 10% of his money. The good investor still makes money from the rest of his other investments which may even cover the 10% loss. In the end, the good investor still makes money from his investments.
One of the distinct factors between success and failure lies in the understanding of risk in investments. We may say that the poor investor above will make a lot of money if stock A really goes up since he put 100% of his money in the investment. But, we have to always remember that the risk of losing all is always there. The poor investor may get lucky one time, two times or even 3 times but just one mistake and he could go back to ground zero. The poor doesn't understand risk and thus do not practice risk management.
Some investors will go further in asset allocation and not just invest their money into stocks. They could invest in different asset classes such as commodities, index fund ETFs, bonds, currency, real estate etc. Also, having an opportunity fund to take advantage of lower prices and invest during crisis is also a smart move. Learn how to allocate your assets like how the good investor always does.
Creating your own financial plan will differentiate you from majority of people out there. Investing should never be the first priority in your life. Get your life in order by using a financial plan, before you start investing.
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