Thursday, May 3, 2012
15 rules of common sense investing :
Investing your money and growing rich requires as much common sense as knowledge about the various investment classes, how they work and how to best invest in them. Common sense investing can be done by anyone who knows the rules of the game and is aware of the following simple principles which need to be applied to his overall financial planning.
1. Understand that time is critical
The power of compounding and how it works is a much raved topic on every financial journal. The common sense investing principle here says that the longer you invest your money for, the more it grows.
And in order for your money to stay invested longer, obviously you have to start saving and investing earlier in your life. That is precisely why they say starting to invest early in your life matters !
2. Personal finance is simple
You won’t believe this, but an ordinary investor can live his life with basic financial products like term insurance, equity diversified mutual funds, debt mutual funds, gold ETFs and some basic fixed income instruments like PPF, NSC, FDs.
You do not need to get caught in the myriad of stocks, ULIPs, money back plans; endowment plans; NAV guaranteed plans – these beat the basic common sense of investing.
3. Know your risk profile
You should invest in line with your risk profile. How much risk you can take is an important ingredient of common sense investing. Know yourself well financially.
The easiest way to do this is to go through our financial health check.
4. Buy and hold, sleep in the interim
You can make millions from the stock market by buying value stocks at a low price and selling them high. But you cannot time the market consistently for profit in your life.
In fact, avoid timing the market. Stay invested for the longer haul. Buy and hold for the longer term.
5. Save money through tax investments
The government allows you to invest in instruments that qualify for tax deductions. If you do not do that, you lose money to the government which you could potentially save.
Small drops of bubbles make an ocean. Save every penny you can for effective common sense investing.
6. Don’t trade
No one got rich quickly. No one will. If you want to trade to make money, remember that you can lose it all. Consider this money lost. Do not consider this in your person net worth. If you cannot hold yourself back from gambling, keep aside a small amount of money each year that you are ready to lose and then trade with that.
In Warren Buffets words “Indeed, we believe that according the name ‘investors’ to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic”.
7. Avoid bad debts
We shout hoarse at this website that personal loans and credit card loans are bad. Close them off. Common sense investing says that loans that build assets are good. A home loan is a good example of a good loan. You create an asset over a long period of time.
Close your bad loans first before you think of investing.
8. Be disciplined
Every month, spend a little and save a little. Financial discipline in your life is a great step forward to mastering your money. Erratic savings, unplanned expenditures and buying products that do not suit you will throw your planned cash flow and your financial life in disarray. Stick to your schedule.
9. Lay your eggs in different nests
Diversify. It’s common sense that investing all your money in only one product could see you lose all your money in case that investment were to go bankrupt.
Spread your money across equity, debt, commodities, real estate and other investments so that the risk of losing money is reduced.
10. Cut your losses
If you buy a stock that nose dives, do not throw good money after bad to average out your cost. Let go of bad investments. You cannot be married to your investments. You would rather cut your losses and invest in a better product than sit with losses hoping to break even.
This is emotionally and psychologically difficult to achieve, but at the same time very important.
11. Rebalance investments every year
If you follow goal based investing approach, each year look at your financial plan to make sure you are on track to achieve all your financial goals in life. This is also the perfect opportunity to look at your asset allocation abd being it in line with what you had decided.
Rebalancing helps you stay on track, close on some profts, clear out the bad investments and be closer to knowing your finances better.
12. Have an emergency fund
This should be on top of your list of to do things. Investing with common sense requires that you provision for mandatory living expenses in a liquid instrument that you can use in case of emergencies.
Emergencies can come in the form of job losses or sudden health issues – you need to be prepared with cash for everyday living expenses like rent, groceries, medicines etc etc.
13. Protect your assets
Your car, house and life need to have adequate life insurance. In case they are damaged, the insurance company pays compensation to bring you financially back on track. Of these, life insurance is the most important. You need to leave behind money for your family in case something happens to you.
Think about personal accident insurance and critical illness as well as it could come in handy.
14. Avoid the noise
There will be times when the stock market would have zoomed northwards or when some investments would look promising simply because they were marketed well. Don’t rush into these investments blindly. Ask yourself whether you really need to run after such products.
Given yourself some time to see where the herd is going with these ideas. You will realize more often that not that these products come down as fast as they went up. Common sense investing teaches you to stop following the herd.
15. Understand finances
It’s your life and your money. You need to understand how your money is invested and why. You need to be able to understand the impact of a sudden withdrawal of money from your corpus on your future life. You need to know what amount you need to invest each month for retirement.
You should be able to understand your overall financial disposition and be able to interpret how you stand financially.
Are there any other common sense investing principles you are aware of ?
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