Five things to consider before investing

Investing is about more than just picking a winning stock. There’s a lot to keep in mind and consider, especially in these volatile times. That’s why we’ve compiled a list to give you the tools so you can make better decisions.

Here’s what you need to consider before investing

1. Make sure you don’t have high interest debt

If you have short-term loans with unsecured lenders, you are probably paying more than 20% in
annual interest.

That’s more than the average return from the JSE over the long run.

Simply put, there’s no investment strategy that pays off as well, at such a low risk, as merely paying off high interest debt that you may have.

So have a look at your credit cards, store cards, personal loans or other unsecured loans. Start by tackling the highest interest one first. Once you have high interest debt repaid – then you should start putting a monthly payment away for discretionary investments.

2. Create and maintain an emergency fund

You should have some emergency savings in place. Sure, disability or unemployment insurance will help you when you are in a bind. But these often take a month or two to pay out. So, you definitely need some emergency funds to ensure you have the cash at least to cover your expenses for a month or two if you don’t get any salary.

3. Consider rand cost averaging

Rand cost averaging refers to buying a stock, or ETF on a monthly basis – and averaging the buying price.

You can protect yourself from the risk of investing all your money at the wrong time by following a consistent pattern of adding new money to your investment over a long period of time.

By making regular investments with the same amount of money each time, you will buy more of an investment when its price is low and less of the investment when its price is high. Individuals that typically make a lump-sum contribution to an individual retirement account either at the end of the calendar year or in early April may want to consider “rand cost averaging” as an investment strategy, especially in a volatile market.

4. Evaluate how comfortable you are taking risk – and don’t invest what you can’t afford to lose

When you look at different investment options you can see their ‘maximum drawdown’ in other words – what the maximum loss you could typically expect if you bought at the worst time possible. For instance – comparing the funds of a well known fund manager I found:

Balanced equity fund – Max drawdown of 34.3%
Bond fund – Max drawdown of 19%
Money Market fund – N/A

What this means is at worst you’d see a loss of 34% on the equity fund, whilst losses on the bond fund would typically be a max of 19%. On money market funds you won’t make losses at all – as these are simply fixed income investments.

But then you need to remember –the equity fund had the best annual return of 49% and an average annual return of around 14%. The bond fund’s best return was 34% in a year, and an average annual return of 10%. And then the money market fund had an average annual return of 7.2%.

This also shows you, you need to take on a fair bit more risk for every extra couple of % of returns you target.

5. Make sure you have a good mix of investments

By mixing different asset classes, like the ones I explained above, you get smoothed returns, and limit risk.

This helps you protect yourself from extreme losses, at the cost of the highest possible returns though. By investing in more than one asset category, you’ll reduce the risk you’ll lose money and your portfolio’s overall investment returns will have a smoother ride. If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category.

In addition, asset allocation is important because it has a major impact on whether you will meet your financial goal. If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal.

Another thing to consider here is that investing too much into a specific individual stock is high risk.

Also – if you get shares from the company you work for you are typically over exposed to the business. And if things were to turn negative for that business, you could end up losing your job and taking losses on the investment. Vice versa – if it goes well, you will be rewarded doubly well… Larger-than-average returns almost always require you to take larger-than-average risks, and there are no free lunches in investing. As you work to build wealth and secure your financial future, these are good tools to start
using.