When thinking about personal finance – what matters are three things: spending, saving and investing; striking the right balance to these is key, whether you are defined as rich or poor. Getting the right mix between spending, savings and investing is one of the major challenge to many of us – except for those who are “lucky”.
Even for these few, figuring out what to do with whatever the amount of money earned and could be spend, saved or invested is not easy.
Among the three (spending, saving and investing), investing is the hardest —whether investing for your life goals, investing for children’s education, investing in preparation for bad times, investing for retirement and financial freedom, etc.
In this article, I will focus on investing, particularly investing in listed shares. Before I get into that — there are many forms of investment and many asset classes that an investor could choose from. One may decide to invest in bonds, term deposits, REITs and CIS units, bonds, etc.
In the process of investing, directly or indirectly, there are risks to be managed, that’s why there are other financial products traded in stock markets that assist investors in managing investment risks — products such financial derivatives, exchanges traded funds, indices, etc.
Narrowing whatever I have just allured into above, let’s focus into some of the factors one would consider when investing:
The point to start with is to determine where you are financially and what is your personal investment goals — as a matter of fact, before embarking on any investment decision, it is recommended that you consult yourself honestly as you can, taking into consideration your financial situation, i.e. you need to figure out your net worth – and how is this achieved? First, it is by adding up all your assets and subtracting all your debt obligations; second, develop a budget by listing all your monthly income and all your monthly expenses. These two steps will tell you how much money you have available for investing.
It is important that you determine how you relate to money and how much risk you feel comfortable taking.
This means, one of the things to consider is figuring out your investment goals versus your level of risk tolerance — sometimes it isn’t easy for one to self-consult, in such cases it is advisable that you consider accessing the advice of professionals. Always remember, there is no guarantee whatsoever that you will surely make profits in your investment process.
What is true though is, if you get rights your facts about investing and with an intelligent investment plan, you can surely gain some financial security and can enjoy the benefits of managing your money in a smarter way.
Once you have a clearly informed personal investment plan, follow on it by evaluating your risk tolerance level: it is important to know that all investments involve some degree of risk.
The degree of risk varies from one asset class (or securities within the asset class) to another. For example, shares are traditionally investments that have high degree of risk compared to bonds or bank deposits. But, it is important to also note a principle of investment that says: the higher the risk, the higher the return.
So, the key is for one to be able to establish the maximum level of investment that s/he is willing to lose in case the investment outcome goes against expectations. In this process, it is good to also determine at which point in time you will need cash for spending, not for investment.
The point of cash need requires careful consideration because under normal circumstances investment in listed shares should be looked into a medium to long-term horizon. Speculative motives and “quick money” mentality should be discouraged. The quick-money strategy is as good a strategy until it is not good for you.
If you are pursuing a goal that have a medium to long term horizon, you are likely to make more money by carefully investing in asset categories with greater risk, such as shares rather than restricting your investments to assets with less risk, like cash equivalents e.g. opening a savings account or a bank deposit.
The other element is for one to determine where you want to end up financially -- this can be achieved by asking yourself specific questions, with related answers.
Questions such as at what age you want to retire, how much money you need in order to retire comfortably, how much time you have between now and then, how much money you need to work with and how much risks are you comfortable and willing to take.
Once you know the answers to these questions you will have a good idea of how much you need to invest to reach your goal. Do not choose to take any road, be specific, i.e. if you are 45 years old and you intend to retire at age 55 and your earning is Sh1 million a month.
This means that for you to achieve the financial freedom during your retirement period, assuming you have not started investing already, you will need to apply this financial model: Take your Sh1 million multiply by 12 months then multiply by the different of years between now and the time you retire i.e. 10 years.
This way your Financial Freedom Target should be to accumulate about Sh120 million by year 2028. This is a simple modelling exercise that excluded other factors i.e. inflation, time value of money, etc. We will continue next week.