INVEST WISELY

At its core, investing money wisely comes down to a handful of behaviors that work together to build wealth. Build enough wealth and you will achieve financial independence - when your investments produce enough passive income to cover your living expenses without you needing a job. 

Since everyone's lifestyle goals are different, this means that the finish line for every investor is different too. Whether you want just enough for a simple life or for an upper class living with flashy cars, your investment strategy needs to follow a few key rules to maximize its potential.

Understand Your Investments

If there is one rule that saves both money and trouble, it is this: never buy or hold any investment you do not understand. You should know how it makes money, what are the pitfalls, and how that money will finally end up in your hands.

The same rule goes for everything from stocks and shares to real estate investment trusts. Jumping in before you are well informed and aware of the dangers, puts your money at risk.

Here are the basic asset classes for investors:

Stocks: This is also known as equities or when you own shares in a public listed company. 

Bonds: Also known as debt or fixed income. You lend money to a government or an institution and will be paid interest in return.

Real Estate: Here, you physically own property. 

Commodities and Precious Metals: As with real estate, you own a physical thing — be it gold, oil, or cocoa. You can trade them, but thankfully, you rarely have to take possession of them.

Futures and Other Derivatives: You own trades (futures, options, etc.), the value of which depends on an underlying asset.

Cash: Also including cash equivalents. You invest your money in an interest-paying savings account or time deposit. 

Proactively Manage Risk

Risk is ever-present when managing your money, and investing wisely requires you to reduce it. If you do not, you could wipe out years, even a lifetime, of your savings.

There are many types of investment risk, liquidity risk, inflation risk, market risk, counter-party risk and fraud risk. One of the reasons it is so important to focus not on absolute returns but rather on risk-adjusted returns is so that you take risk into account.

For most investors, the most successful way to drastically reduce risks of all kinds is to use amortization, diversified portfolios, and long-term investments. Amortization means you spread out the purchase of an asset over a span of time. Diversify your assets to include stocks, bonds, commodities, mutual funds, and real estate. Then hold your investments for the long term, which will offset any short-term losses with long term gains.

Couple this strategy with large cash reserves and you create a sizeable cushion in the event of a job loss, recession, stock market collapse, natural disaster, or other unexpected situations. Keeping some of your assets liquid also allows you to buy assets on the cheap when the opportunity arises.

Take Advantage Of Compound Interest

Wise investing means harnessing the power of compound interest. Compound interest accrues on your interest as well as your principal. It accelerates the growth of your money exponentially over time. The younger you start, the greater its effect on your net worth.

To illustrate the concept, imagine three investors: Ahmad, Betty and Chan.

Ahmad's parents invest RM 100 a month in his account every year from birth until Ahmad turns 21 years, at which point he takes over, continuing the same rate of RM 100 per month until the age of 65 years. Assuming an average rate of return of 10%, he will end up with RM 6,149,231 at the age of 65 years.

Betty does not start investing until the age of 18 years and invests RM 400 every month. Assuming the same average rate of return of 10%, she will end up with RM 4,382,833 at the age of 65 years.

Chan does not start investing until the age of 45 years, at which point he invests RM 5,000 every month. Assuming an average rate of return of 10%, he will end up with RM 3,624,934 at the age of 65 years.

Despite Chan investing 50 times as much per month as Ahmad, Ahmad ended up with almost twice the money that Chan did because he invested longer. That is the power of compound interest.

Invest Money To Accomplish Long Term Goals

Investments are the opposite of savings because they are meant to grow money that you spend in the distant future, namely in retirement. Investing is also best for smaller goals you want to achieve in at least 5 years, such as buying a home or taking a dream vacation

So, start investing a minimum of 10% to 15% of your gross income for retirement. Yes, that is in addition to the 10% for emergency savings. Consider these amounts monthly obligations to yourself, just like a bill with a due date you receive from a merchant.

If saving and investing a minimum of 20% of your gross income seems like more than you can afford, start tracking your spending carefully and categorizing it. I promise that when you see exactly how you are spending money; you will find opportunities to save more.

After you build up a healthy emergency fund, continue putting aside 20% of your income. You could invest the full amount or invest 15% and save 5% for something else, like a new car or a vacation.

Choose Investments Based On Your Horizon

Your investment horizon is the amount of time you need to keep your investment portfolio before spending it. For instance, if you are 40 years old and plan to quit working and live solely on investment income when you are 65, you have a 25-year investment horizon. This is important to consider because, in general, the longer your horizon the more aggressive you can afford to be.

If you have at least 10 years to go before needing to tap your investments for regular income, you have plenty of time to recover from temporary market downturns along the way. But as you get closer to retirement, it is wise to shift more of your investments into less risky investments so you preserve your wealth.

In general, stocks are the riskiest investments because their value can change daily; however, they offer the highest returns. Bonds are less risky because they offer a fixed, but lower return. And cash or cash equivalents, such as money market funds, give you the lowest, but safest returns.

You might allocate your stock percentage to a variety of stock funds or put it all into one stock fund. The remaining amount would be in other asset classes such as bonds and cash.

Avoid Investment Funds With High Fees

Different funds charge different fees, known as the expense ratio. For instance, an expense ratio of 2% per year means that each year 2% of the fund's total assets will be used to pay for expenses, such as management, advertising, and administrative costs. 

If you can choose a similar fund that charges just 1%, that may seem small, but the savings really add up over time when you consider that they come off your potential annual return.

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