Money

How to Stop Making Dumb Investment Decisions

How To Avoid Dumb Investment Decisions

Six Simple Principles to help take the Madness out of Investing

Here are six principles to help you avoid making dumb investment decisions. The points below are generic and for consideration only and are not offered as guidance or advice. When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


1. Consider Professional Advice

Some investors make catastrophic investment decisions because they don’t seek or value professional financial advice. The value of Professional Advice is highly dependent on individual circumstances, the nature of the advice and the quality of the adviser.

Professional advice will not always be necessary, possible or even appropriate. The point is to consider the value of professional financial advice to you before you make important financial decisions. Where you feel that professional advice could be beneficial do your research and due diligence to find an appropriate suitably qualified and competent adviser.

Ensure you are clear on the costs of any professional advice up front as well as the scope and limitations of that advice. Note that some advisers will limit their advice to a particular advice area or product provider. When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


2. Remember Your Time-Horizon

Time horizon is how long you can invest before you need the funds back. Investing in equities and other risk based assets is typically a long term approach. Assets of this nature can be very volatile in the short to medium term which typically makes them unsuitable for most short term financial objectives.

Many investment providers will typically suggest you only consider risk based investments such as stocks, shares and bonds if you can leave these funds invested for the long-term without needing to draw on them. The definition of long-term will vary across providers and nations however around five years is typically considered to be a minimum time horizon to consider any risk based investment.

Time horizon is so important to investing because it’s acutely correlated with an individual’s ability to take on risk and their capacity to absorb any losses. An example would be a pension. When you have 30 years until retirement you could have a significant period of time to ride out any market downturns or recover investment losses. On the contrary when you’re a year from retirement you potentially have much less ability to take on risk because you don’t have the same time to ride out market volatility.

Typically it may only make sense to invest in risk based investments where you have the time horizon to adopt a long-term approach and attempt to ride out any market downturns. When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


3. Invest in line with your Attitude to Risk

Taking on excessive investment risk which is beyond what you are comfortable with is gambling and not investing. Investing is about taking on calculated risk that you understand, are comfortable with and have the ability and time horizon to accept.

When you take excessive risks to chase “quick and easy returns” this is almost always doomed to failure. One reason why this may fail is because it’s extremely difficult to time the market and predict future events. When you are looking for shortcuts it’s easy to get burnt.

Understand The Risks
Understand The Risks

Risk and reward are correlated in that investors expect a higher potential return the riskier an investment is. For example a low risk investment such as a UK Government Gilt may typically pay a minimal return as the risk to the capital is perceived to be low. Conversely investors in equities for example expect higher potential returns as the risk to their capital is potentially much higher.

Where the risk comes to the fore is in the fact that an investment may pay no return or the capital invested could even be lost in full. The greater risk involved in an investment, the greater the chance of losing some or all of the capital invested.

The key point here is you should always invest in line with your attitude to risk, which is essentially how much risk you are comfortable and willing to accept. Your willingness to accept risk should be considered alongside your time horizon (see point 2) and your ability and need to accept risk.  When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


4. Build on Solid Ground

Before investing it can be sensible to ensure your overall financial position is sound and start your investment journey from a position of strength. 

Investing when you’re heavily indebted or financially stretched could increase the chance that you need to draw on your investment in the short to medium term just to live. This increases the risk that you may need to encash an investment when its value is low.

Solid Foundations are Key
Solid Foundations are Key

Typically it could be beneficial to focus on clearing high interest debt such as credit cards or unsecured loans before considering investing at all. Having surplus income each month and healthy cash balances for emergencies protects you and your investment strategy by better enabling you to adopt a long-term investment approach and ride out market volatility.

The financial author Dave Ramsey has written some excellent material around these principles and to learn more I would highly recommend his book the total money makeover – View on Amazon.

When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


5. Maintain Adequate Cash Funds

Maintaining adequate cash funds links in with the last point of building on solid ground. It is absolutely essential when developing a financial plan to ensure adequate cash is available for both unforeseen expenses and also for known future expenditure.

For example investing every penny you have today when you are intending to buy a property in a year could be incredibly dangerous. If markets were to drop you could see heavy losses and jeopardise your plans to buy a home. Similarly unforeseen expenditure such as loss of your main income or car repairs could see you without the funds you need to survive.

It is absolutely essential when investing that you consider planned and unplanned expenditure and allow cash for both. This in turn helps you to protect your investments as it reduces the risk you could have to panic sell these to free up cash. When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


6. Diversification is Key

Diversification is a risk management technique that mixes a combination of different types of investment and holdings within one portfolio. The rationale behind diversification is to reduce the risk that the failure of one company share, segment or asset class can wipe out a portfolio full value. By diversifying the risk is spread and can help protect some of an investments value in volatile markets, although risk cannot be diversified away in full.

When investing you should consider your diversification. Holding all of you assets in a particular company, segment or asset class is considered very risky as the impact of a downturn in that one area would significantly impact the value of your investment. Diversification is about spreading an investment across lots of different areas to achieve the optimal balance of risk and potential reward for your chosen risk level.

When investing you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances.


Conclusion

Investing is by its very nature risky and you should always consider professional advice from a suitably qualified and competent financial adviser who understands your individual needs and circumstances. The points above are generic and for consideration only and are not offered as guidance or advice.

I hope you found the information in this article useful. You may also like How to Achieve Anything and How to Accumulate Wealth From Nothing.

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