Basics of Investing & Portfolio Management

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Determine Your Investor Personality

Lesson 2

In this section, we will discuss all the different traits that define your personality as an investor, which will determine what investment strategy you should follow.
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Table of Contents

Step 1: Your Investor Personality

Your personality as an investor defines your ideal strategy your overall investment strategy will be the foundation on which your portfolio will be built.

In the Asset Allocation: Factors lesson we started looking into the factors that describe your personality as an investor and how that relates to your portfolio construction.

Before you start investing, it is important to take into consideration all the points we will see in this section, that’s why we called it Step 0, because it is the step prior to getting started. So, let’s dive in a little deeper and create a very simple, but powerful guide to define your personality and create your investment strategy:

Time horizon

How old are you? how long do you want to invest?

These are some of the most important questions you may want to ask yourself. It is not the same to invest as a 25-year-old than as a 55-year-old. Your investment time horizon (timeframe) is one of the major factors in determining your risk-taking ability. Theoretically, younger investors can generally take on higher risks than older ones because they have more time to recover from any downturns and they typically have less financial responsibilities. Let’s see an example:

  • Jim is a 23-year-old college graduate that is just starting his professional career. He is planning to start investing very soon and has a long-term mindset when it comes to investing and wealth growth.
  • Hannah is a 56-year-old married, working, and mother of two. She is saving to send her kids to college soon and she sees that she is getting closer to retirement; therefore, her time horizon is significantly shorter.

Implications:

Investors that are planning on investing in the long-term are more likely to accept higher levels of risk in their portfolios because they have more time to ride out any economic downturn. Contrarily, investors that have a more limited timeframe (short-term) may not want to take on a lot of risks, since they have a smaller cushion, less time to recoup any downturn losses. 

However, the above statement is not always true. An investment strategy can’t be based solely on the investment time horizon as we will see below. 

Risk Tolerance

How much risk are you willing to take? how much can you allow yourself to lose?

Questions that define your risk tolerance, which is one of your characteristics as a human being and as an investor. This is a simple concept and it appears to be binary, you may either be an aggressive investor or a conservative investor. You may like to take on risks to get higher returns or you may prefer preserving your money and not dealing with big losses. However, we believe risk tolerance is a more unique trait of your personality. It is not black or white (aggressive or conservative). It has many levels and it affects everyone differently. To show how risk tolerance is a unique trait, we will continue Jim’s and Hannah’s example:

  • Jim seeks excitement in most of what he does; he loves surfing and jumping off cliffs, so it seems logical that he would be a risk-taking investor. However, he grew up in a very humble family and he had to save everything he could to have food on the table. Because of Jim’s upbringing, he is now very protective of his money and lives a frugal life; therefore, when he starts investing he will look for safer options that won’t generate huge returns but won’t fluctuate a lot.
  • Hannah, on the other hand, has owned her own successful business for over 20 years and has started two more ventures. She is a driven success seeker that stops at nothing and when it comes to investing, she enjoys seeing great returns and doesn’t mind some hiccups.

Implications:

Risk tolerance is a very unique trait in everyone’s personality. People see risks differently, they behave in their particular ways when faced with difficult situations. Therefore, it is important to understand the risks you are about to take before you actually jump in. 

Expertise & Guidance

How much do I really know about investing? Should I look for help?

True investing is about making smart, educated decisions and to take controlled risks in order to achieve the best results while suffering as little as possible. To do that, it is important to have a solid knowledge base and to understand what good and bad risks are. Expertise is important in investing because it’s can help you make the right decisions and avoid the bad ones. 

Generally, experienced investors can take on more risks since they have the tools to make better decisions. However, this doesn’t mean that you can’t invest unless you have a master’s degree in finance; what we are saying is that investors that are just starting or that don’t have much experience in investing should look at lower-risk investments. 

How should I invest if I have little to no expertise?

It is easier now more than ever to start investing with little to no knowledge. As we have seen in previous sections, thousands of mutual funds and ETFs will provide you with the right exposure you need and will take very little effort from your end, as they are cheap, easy to get and very liquid.

When you are starting to dive into investing, using these funds is great to get some easy growth and to get a feel for how investing works.

In the meantime, we recommend that you learn as much as possible about the stock market and how to develop great strategies. Our courses are created specifically for this purpose, in order to help you grow as an investor and provide you with the tools to make the right investment choices. If you want to trade in the stock market, reading the business newspapers is a great source of knowledge and current event (visit our News and Data Center to get the most current news).

We understand that investing is not for everyone; so, if you are not interested in learning about the markets and investing but still want to get some exposure to capital growth or some extra income, we recommend you seek the help of a financial adviser that can assess your needs and work with you.

Investment Capital

How much money should I invest? How often should I add money to my investments?

The amount of money you can (or are willing to) invest will be one of the determinants of your overall investment strategy and how much you will invest. This decision should be based on your current financial situation. You should take the following into account to assess your financial well-being:

    • How much do you have saved up? And, are you saving enough to meet your obligations?
    • How much do you make a year? A month? A week?
    • How much debt do you have?

Once you have answered those questions, you may want to consider the other side of this, which treats the level of capital you are willing to invest:

    •  How much should you invest?
    • How often should you add money to your investments?

As a general rule, we recommend investing between 10% and 15% of your salary, given that you save at least 30% of your salary. That means that you would have to set aside that percentage for every paycheck and invest it. For instance, if you make $52,000 a year and get paid weekly, you’d get paid $1,000 a week. If you follow our previous advice, you would be investing between $100 and $150 a week, which is $5,200 to $7,800 a year. At an average yearly growth rate of 10%, your investment would grow up to between $330,000 and $550,000 after 20 years if you are consistent!

Below we exemplify a few critical ideas that are essential for one’s financial well-being, pay attention to how our example develops:

  • Jim just started working and makes $36,000 a year, or $3,000 every month. He is living with his parents and saves virtually every penny he makes. He has about $10,000 saved up already and has almost no financial obligations. He has some $5,000 in debt because he is paying off his car. So, he decides to start his investing with $2,000 and will add another $600 every month (20% of his salary).
    • He is planning on investing for 30 years and thinks an 8% annual return is achievable.
    • At the end of the 30 years, he expects his investments to have grown to almost $1,000,000!
  • Hannah, as we saw, has her own business which provides her with $90,000 a year, so she pays herself $7,500 every month. She has two kids and lives a luxurious life, she ends up saving about $10,000 a year and has many financial obligations (mortgage, car payments, kids’ schools, clothing, etc.). She has about $150,000 in debt because she is paying off her fancy house, her two cars and some credit card debt. So, by analyzing her financial situation she sees she can only invest about $250 a month and starts with a $1,000 investment.
    • She doesn’t mind taking on some risk so she expects to generate a 12% annual return and plans to invest for 10 years until she retires.
    • At the end of the 10 years, she expects her investment to have grown to slightly over $60,000.

Implications:

Fully understanding your current financial situation is crucial before making any future financial decisions, including investing. You should invest when you have the money to do so.

As we have seen in the example, income does not always translate to savings (Hannah generates more income than Jim but gets to save significantly less). This is a very important topic in personal finance that we will revisit in future segments, but it also affects your investments, as you should invest according to what you make and never more than what you save.

Goals & Objectives

Why do I want to invest? What do I need the money for?

Before you decide to invest or make any decisions, it is important to know what you truly want to get out of investing. This will help you find the right strategy and then, once you get to investing, it will you stay on track and consistent with the strategy you chose.

Our financial goals can affect our level of risk tolerance significantly. Since we should adapt our strategy to meet our objectives in different moments of our lives, our level of risk tolerance may also vary with our ever-changing needs.

Setting specific goals is key

Just as in most aspects of your life, in the investment world, setting detailed goals can really make a difference and will help you get there faster. For instance, instead of saying “my goal is to buy a house”, specify the desired value of the house and when you want to make the purchase: “my goal is to buy a $200,000 house in 3 years”. This way you have a clear idea of what you need and when you needed, which will help you figure out the steps to get there.

Write your goals down!

It is important to make a written list of your goals. This will help you stay the course. We recommend listing your short-term goals, your mid-term goals and your long-term goals separately and in order of importance to you.

Let’s see a quick example:

  • Short-term goals:
    • Help pay the monthly rent of $1,000 in 25 days
    • Help pay for college loans of $400 in 20 days
  • Mid-term goals:
    • Pay for next year’s summer vacation of $2,000
  • Long-term goals:
    • Buy a house worth $200,000 in 10 years
    • Pay for my children’s tuition of $60,000 in 18 years
    • Have $700,000 in my retirement savings when I turn 62 

You may rely more on your salary in order to achieve your short-term goals. However, investing can also help you with those. For instance, if you have $100,000 invested and you get a 3% annual dividend yield, you’d be getting $3,000 in cash every year just by holding those assets; and, even though we recommend you reinvest that money, you can use it to help you pay for utilities, or insurance, or rent.

Investing can help you reach your long-term goals

Everyone’s goals are different; however, we believe that following these steps can help you achieve them:

  1. Estimate the cost of your goal
  2. Set a timeframe
  3. Separate your investments 
  4. Create a strategy
  5. Be consistent with your strategy

Now let’s see an example of how to put this process in action:

Imagine your child was born today, and you start thinking about the future. You decide to make the following plan in order to afford your kid’s education:

  1. Estimate the cost of your goal: you anticipate tuition will cost $60,000
  2. Set a timeframe: probably, your kid will go to college at 18 years old (so 18 years is your timeframe)
  3. Separate your investments: set a separate education fund specifically for this purpose
  4. Create a strategy: this will depend on your financial situation, risk tolerance and expertise. But setting a strategy could be something like:
    • Invest $11,000 in the education fund in a portfolio that is expected to generate a 10% annual return to get about $60,000 in 18 years.
    • Or, invest $5,000 today and invest $2,000 every year in that same portfolio to get the result.
  5. Be consistent with the strategy and keep an eye on your investment (or have a professional do it for you)

Throughout this section, we have discussed some of the characteristics that define you as an investor. You must have a clear understanding of each and every one of the traits we’ve discussed before you actually start investing. 

In the next section, we will discuss Step 1: develop a good strategy. This will be a critical step for you to achieve your pre-defined goals.

Plan, Build, Monitor

Your Portfolio Strategy

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