If you have the slightest idea about inflation and the time value of money, the importance of investment can be well understood. In South Africa, you could have bought a medium-sized house for around R30,000 in 1980, but in 2020 you need more than R1,500,000 for the same. This means that if you do not invest your money in the right investments, you are probably diminishing its value over time as money is constantly affected by market, economic & geopolitical forces. Consider this, Rand has fallen almost 17% in last 10 months against US Dollar, making imports expensive – this is just one such example of market forces affecting your money. Right Investment can help offset these forces to some extent. And earlier you start its better. Investing means committing money to earn a financial return in the future. Every time you invest money you are giving your money to a certain company, government, or an entity to acquire assets or guarantees or shares in a form of a financial instrument with the hope to get more money in return at some point in time in the future. Investments can be done in multiple instruments depending on your risk appetite and financial literacy to achieve financial objectives like retirement planning or buying a house, car, etc. However, it involves risks that you need to be aware of, as there might be cases where you won’t be able to get the desired money in return, and might lose the invested amount. Capital markets always involve risk which must be lowered by every investor by taking appropriate steps. Here are some points that every investor needs to follow and take care of before investing in any capital market to achieve better outcomes.
- Educate Yourself Before Investing
A lot of investors face unwanted outcomes in their initial investments due to a lack of knowledge and experience regarding the financial instruments, market data analysis, money management, risk management. It is important to understand every aspect of the capital market to ensure the investment decisions made are suitable or not. Investors should know about all the available financial instruments in South Africa and their pros and cons before making a selection. Investors should also ensure that the chosen capital market is overlooked by the concerned regulatory authority in South Africa. Ensuring the regulation and checking the safety features before investing can play a vital role in controlling the risk factor. Investors should also know about the available features while make investments to make sound decisions & to minimize their risk – like stop loss, margin, etc. in case of day trading or forex trading or CFDs.
- Make a Plan & Stick with it
Investment should always be done according to the financial objective of the investor like buying a car/house, retirement planning, etc. Without a predefined financial goal, the investments can disrupt your financial condition and may lead to fatal losses. A smart and insightful investor should have a predefined financial objective, make a strategic plan to achieve it, and stick with the plan until the goal is achieved. The financial planning should also take care of the basic financial needs, liabilities, emergency fund along with savings. The income should be divided in order to accommodate each expense after investing the required amount to achieve your goal. Further, you must also plan your investment portfolio with an investment strategy/plan like where you will invest and how much, what term you will for and what if you lose value in investment or investment does goes as planned. All these things have to be taken care in your plan. It is important to stick with the plan regardless of the market conditions. The investment amount should never be compromised during tough times or for leisure activities.
- Select a Suitable Financial Instrument
A large number of financial instruments are available in South Africa, each of which offers different returns & have different risk factors. The investor must be able to choose the most suitable instrument for oneself depending on his/her financial objective, risk appetite, and financial literacy. The instruments carrying high-risk factors normally tend to deliver higher short-term returns, while the ones considered less risky generally provide lesser gains or are long term investments. The price movement of each instrument is affected due to different reasons and investors must be able to identify and analyze the pros and cons of each instrument. Suppose: You are layman with no financial literacy and investment experience, term deposits or mutual funds/unit trusts can be an ideal stop to start the investment journey as they are managed by licensed financial institution like bank or fund manager for you. Mutual funds are considered ideal for beginners as it requires lesser experience and financial literacy, you need to read to offer document to help you understand risks and terms. The assistance of a licensed financial advisor can be quite helpful in selecting an ideal fund. For those with an appropriate experience in investments, financial education, higher risk appetite, and an ability to analyze the trends and potential of stocks, equity investment could be a good option. Leveraged Forex, CFDs, and cryptocurrency trading involve even more higher risk in which investors and traders take the advantage of volatility in price movements via speculation.
- Know Your Risk Threshold
Investment should always be done according to your risk appetite. You must know the amount of money you can afford to lose and its compatibility with the selected instrument. Markets that offer significant and attractive returns also involve equivalent risk factors. Investors should try to understand each and every type of risk associated with the selected financial instruments. Even after taking the accurate steps, investors must be prepared for the risk involved in each capital market. For example, the share price of MTN (traded on JSE) went from R8,860 on 20th Feb 2020 to R2,948 on 23rd March 2020, due to COVID-19. Some elements in any capital market carry higher risk while some are less risky. A smart investor must be able to invest in an instrument that carries lesser risk and can deliver good returns in the long term. Multiple types of risks can negatively affect the investment in case things go wrong. The types of risk in investment involve market risk, liquidity risk, credit risk, inflation risk, reinvestment risk, concentration risk, longevity risk, etc.
- Risk vs Reward
After considering the risk factors, it is important to check whether the selected instrument is worthy of the risk or not. The possible gains from a particular investment must be higher than the risk associated with it. If you are putting R50,000 at risk to make a profit of R20,000 then the risk to reward ratio is 5:2 which is not ideal for investment. Ideal risk to reward level should be 1:2 or 1:4 or even lower. The risk to reward ratio can be marginally reduced by using the stop loss feature, if available, in the capital market. Stop loss limits the losses and keeps the position open for the profit opportunities.
- Knowing & Managing Risks
A successful investor must be able to identify and mitigate each risk element to the lowest level. Risk management includes identifying, evaluating, controlling, and lowering the risk factor in investments. Each type of risk can be mitigated by different measures. Choosing a trusted and well-regulated broker or dealer can lower the third-party risk like – choosing a reputed forex broker with FSCA license would reduce this risk for CFD traders. Detailed research and analysis of an investment can lower the market risk. Similarly, investors should try to reduce every risk element to the lowest levels in order to garner best possible returns from the investments.
- Portfolio Diversification
Diversification in the portfolio is very important and has multiple benefits in long term investments. The portfolio of each investor should include different types of financial instruments in the required proportion. Under the worst case, if any element of the portfolio provides significant losses, it would be balanced off if the portfolio is diversified. A well-diversified portfolio lowers the market risk by spreading the risk factor of each instrument in the portfolio. Diversification also supports the portfolio in delivering consistent gains. In case, if any element of the portfolio is not performing as per the expectation, it should be removed and a better performing instrument can be added. It must be noted that each element of the portfolio should support the overall gains while the added instrument should be suitable for the investment objective and financial literacy. Regular monitoring of the portfolio must be done to maintain consistency in returns and remove non-performing elements.
- Discipline and Consistency
Discipline and perseverance in investments can turn droplets into ocean. One cannot simply become rich within a week or with a single investment. Each financial objective requires a disciplined and consistent investment for a fixed amount of time. Disrupting the investments or withdrawing the invested amount when the market is bearish or bullish is malpractice. At times, the asset prices become lower during the bearish market which makes investment cheaper and allows the investors to gain better returns in the long term. Investments must not be stopped until the objective is achieved.
