Investing may not be rocket science, but it does require basic understanding. First and foremost, it is important to understand yourself as an investor, before selecting the right investment options. A portfolio that is just right for you may not work for someone else. This is because each individual has a different attitude towards risk.
Further, each individual has a different set of financial goals depending on which stage you are in in your life. Thus, while it is correct to state that everyone has a different investment selection philosophy, the ground rules for sound investment selection remain the same. They are:
Understand your risk tolerance
This is the first and foremost step of investment. Know yourself, your risk appetite before taking the next step.
Identify your financial goals
Different life stages demand different life goals. For instance, if you are just beginning your investment journey, you may have a short-term plan of going on a family vacation. Your medium-term goal may be to buy your first home a few years down the line. Finally, you may also want to save for your retirement that is 30 years away. This can be classified as a long-term goal. For each of these goals, you need to plan differently and may have to invest in different financial products to meet each of these goals. This process of selecting various investment options based on your financial goals is called asset allocation.
Diversification is the key to success
While investing, you do not want to put all your eggs in one basket. The key to success is to diversify. But diversification too, has to be according to your risk appetite. You may thus wish to diversify among different asset classes such as equity, debt, real estate and commodities. This is called vertical diversification.
You can also diversify within the same asset class. This is called horizontal diversification. For instance, if you are investing in equity mutual funds, you may want to invest in a combination of large cap and mid cap funds to spread your risks. Similarly, if you are investing in debt funds, you can choose fund with varying durations. The duration of the fund, determines the level of risk in a debt fund.
Avoid what you don’t understand
Do not go overboard in your effort to diversify. At all cost, stay away from financial products that you do not fully understand or know the specific risks they entail. Consider high risk or complicated products only when you have the raequisite knowledge.
Keep monitoring your investment status
Once your portfolio construction is complete, you need to keep a watch over it to ensure your investments are meeting your financial goals. It is always best to review your portfolio at least once a year. However, don’t keep a tab on your investments on a daily basis. That’s because you may be tempted to act every time markets move unexpectedly. Such decisions may work over a short period but may not help you meet your long-term financial goals. Remember that volatility is part and parcel of the market movement, and you have to accept this fact if you are a long-term investor.
The bottom line is that there is no one “right” way to select investments. But so long as you are focused on your financial goals, these ground rules should hold good under any circumstances.
Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.