While stocks have historically offered the greatest potential for investment returns, it may not be suitable for all investors as there many considerations involved. For one, stock investments carry a greater level of risk as compared to other asset classes, and investors can potentially lose a substantial amount of their investment capital during stock market crashes, which are far from unprecedented. We have put together a list of considerations to help investors assess their suitability for stock investments, before they actually plunk down their hard-earned cash. Knowing the answers to these questions does not guarantee financial success, but it is certainly a solid start towards making better and well-informed investment decisions.
1. Are Your Finances In Good Shape?
Before making an investment in a stock, you should first assess your current financial situation and make sure you have the funds available to make the commitment. If you overstep your financial boundaries while investing in stocks, you are setting yourself up to fail in the stock market. You should ensure that you are properly insured, have at least six months' worth of living expenses in emergency funds, and as little debt as possible. Without a solid financial foundation, you are at risk of not having cash when you need it or having to liquidate your stock investments early.
2. What Is Your Investment Horizon?
Investment horizon refers to the length of time you expect to hold your investment for before selling if off. When contemplating a stock investment, it is important to determine what your investment horizon is. If you have a financial obligation that is coming due in the short-term, investing all your cash into stocks may not be a good idea. On the other hand, if you do not have a need for liquid cash for a long period of time, you can afford to own a riskier mix of investments in your portfolio, with a greater proportion allocated to stocks. In general, the longer your investment horizon is, the more risk you should be willing to accept, as you have more time to ride out any short-term volatility in the stock market.
3. Do You Have The Relevant Knowledge?
One of Warren Buffett's homespun investment philosophy has always been this – that investors should only invest in what they know – and it is certainly not without merit. There are several reasons why you should invest only when you understand how a particular stock investment works. Having the relevant knowledge gives you the ability to make well-informed investment decisions, which is essential when you have your money on the line, and you are also more likely to avoid serious investing mistakes and scams. If you invest in a company that you cannot fully understand, you could be in for a nasty surprise when the value of your stock holding declines suddenly. Back in 2013, a crash in the stock prices of Blumont Group, LionGold and Asiasons Capital over suspected stock manipulation wiped out billions in stock market value over a span of just a few days, leaving many investors with huge losses.
Here's the bottom line – if you don't understand how a company derives its revenues, its competitors, the risks and opportunities facing the company even after putting your nose to the grindstone, then it may not be a good idea to own the company's stock. For investors who are not confident of investing in stocks on their own, they can consider approaching their financial advisors. At Fundsupermart, we have a dedicated team of Investment Advisors to assist you with your portfolio construction decisions and to answer any questions you might have at no additional cost.
4. Does It Fit Into Your Portfolio?
Not only should a potential stock investment be considered in silo, it should also be assessed together with the rest of your portfolio holdings to ensure that your portfolio is well-diversified. If you have ever heard of the proverb, "don't put all your eggs in one basket", you will probably understand the concept of diversification. Diversification involves spreading your investments across a wide array of asset classes, geographies and segments to help protect your portfolio from the effects of any one market trend, event or setback. As such, it is better to be diversified across different sectors and geographical markets. If your stock portfolio consists only of Singapore companies, you can consider either a US or a Hong Kong company as your next stock investment. You can also consider diversifying your investments across different asset classes by keeping some money in bonds or unit trusts. The key is to have an asset allocation plan that determines your investment mix and the respective weightings in terms of asset classes and geographical markets, based on your financial objectives.
5. How Comfortable Are You With Risk?
When it comes to investments, here's a reality check: all investments carry some degree of risk. In other words, you may lose some or all of your investment capital when market conditions turn sour (an investment that promises 'guaranteed and consistently high returns' is likely to be a Ponzi scheme). As such, before making an investment in stocks, you should always think about how comfortable you would be if the value of your stock holdings were to decline. Some investors are uncomfortable with losses stemming from short-term fluctuations in the stock market, such as the gut-wrenching downturn we saw in the recent global financial crisis, and prefer investments that are less risky so that their principal capital can be preserved. If you are one of them, recognise your emotional boundaries and construct your portfolio accordingly, with your portfolio's stocks allocation limited to a level that is consistent with your risk tolerance.
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