Before making an investment decision, you must ask what you expect from the investment, how it fits into your portfolio, and understand the risks involved.
Speaking to Bruce Whitfield on The Money Show, Rand Swiss director Gary Booysen shared seven questions you should ask yourself before investing. You can remember them by using the acronym RETURNS.
Each letter of the acronym stands for an important question you should ask, which are:
R – what are the risks involved in your investment?
E – what are your expected returns?
T – how much time are you willing to leave your money in the market?
U – what is your ultimate goal?
R – what are the rates you’ll pay?
N – what is the nature of the investment?
S – what is your portfolio’s situation?
Booysen said learning and applying these questions in the proper context could make investing less daunting and bring you peace of mind.
The context in which you should ask yourself these questions, with an explanation of why Booysen believes these questions to be necessary, is explained below.
Understand the risks when considering an investment
Booysen said many people don’t invest in the market because it’s “risky”, but you are already running a type of risk by not investing.
“By not investing your money, you are exposing yourself to longevity risk, which is the risk of outliving your money,” he said.
Many people concern themselves with the returns side of the investment and don’t pay enough attention to the risks involved.
The risks you should consider before you invest include:
- Market risk – the risk of losses in positions arising from movements in market variables like prices and volatility.
- Geographic risk – the ramifications regarding the jurisdiction to which your investments are exposed.
- Currency risk – if you want to invest overseas, you run exchange-rate risks when a financial transaction is denominated in a currency other than the company’s domestic currency.
- Liquidity risk – relates to the time it would take to sell your assets and convert them into ready cash without affecting the market price.
- Management – who are you investing with? Are they licensed and reliable? As an investor, you can check this via the FSCA website.
“With the power of the internet, it is easy to do due diligence and make sure you understand the risks involved with your chosen investment,” said Booysen.
Identify the return you’re looking for before you invest
Like any investor, you invest with the expectation that your money will make more – regardless of the type of investment.
However, one of the biggest mistakes investors make is that they focus on the historical returns of the product and believe that this will be the expected return.
“While historical returns are a useful indicator, it is far more important to understand the fundamental composition of the investment opportunity,” said Booysen.
Investors need to look into the company they are investing in and understand their operations, their industry potential, and what dividends it pays to get a good idea of what type of return they’ll get.
These aspects are part of the company’s fundamental composition, and this is the best way to align your portfolio with the returns you expect your money to make when invested in the market.
Time in the market is better than timing the market
Time is fundamental with anything to do with investing, and you should consider what the time horizon is for your capital to make the expected return.
Before making any decision, it is crucial to understand the time to maturity of your investment in relation to your goal.
Whether you want to save for a car, your children’s education, or save for retirement, the length of time you wish to keep your money in the market will determine what product you want to go for.
Expecting high returns in a short period may expose you to more risks as you’re likely to invest in products that are high-risk investments.
While short-term investments may result in higher returns in a short period, it also carries a relatively high chance of a devastating loss.
Conversely, if you leave your money in an investment over a long period, you take on less risk as you ride out the market cycles, reducing the effects of volatility.
Once you’ve decided on your timeframe, you can determine whether the market is the right place for you and, if so, what products will cater to your expected returns.
Have a specific goal
Before making an investment, you have to have a specific goal in mind, which ties into the decision you make when answering the previous question.
Look at what you’re trying to achieve by investing, for example, whether you’re trying to generate capital gains or income.
Booysen said that this would dramatically affect what type of product you choose.
“You can’t understand the risks and outcomes of an investment plan, such as the tax implications if you don’t come up with a goal that you are ultimately trying to achieve,” said Booysen.
Investigate the costs associated with your investment
The broker rates you may have to pay to invest can dramatically affect your returns.
Booysen said it is vital to take note of the fees you’re liable to pay when investing on a platform or with an investment firm.
“The fees you pay over to a third party are important, as they ultimately taken out of your investment sum and therefore won’t compound over time and contribute to your return at the end,” he said.
Booysen advised that investors need to understand the math and interrogate the broker on their fees.
For example, fees usually average 2.75% of your investment plus VAT, while a Tax-Free Savings Account (TFSA) charges almost nothing.
Booysen suggests that investors should vet their fees by comparing them to other offerings in the market to ensure it’s in line with market standards.
Understand the nature of your investment
There are many different types of investments, and the main three include:
- Stocks and bonds – where stocks pay dividends and bonds pay coupons.
- Property – which pays rental and provides capital appreciation
- Alternatives include Kruger rands, expensive wines, etc., generating returns based on scarcity.
These investment classes have different regulatory statutes and require varying amounts of time to be invested in ensuring a return.
By understanding the nature of the different investment options, you can decide which one is best suited to your goals, expected return, and what risks are involved.
Consider your portfolio
An essential aspect of investing is diversification, which is spreading your investments around so that your exposure to any one type of asset is limited.
This practice is designed to help reduce the volatility of your portfolio over time.
“Any investment you make should be in the context of your other investments,” said Booysen.
For example, if your entire portfolio is sitting in a global stock portfolio, then you shouldn’t look at another global stock portfolio as your next investment.
It would be best if you generated non-correlated asset classes, and having a diversified stock portfolio is an excellent wealth-building strategy.