If we want to invest money successfully, each strategic step to investing requires our undivided attention or else this could lead to serious investment mistakes, which usually translate into loss of money. The good news is that we can avoid 99% of investment mistakes by identifying the right financial assets to buy and knowing how much money to put into them. Interestingly, this is a lot like going to the supermarket and knowing what to buy for a value budget.
1. How much to invest
One very important question is how much money should we allocate each month to savings ? should it be 1%, 25% or 100% of our regular income ? The answer will depend on our lifestyle and the financial needs of our future projects. Even though 100% is a bit excessive and not realistic (we need at least some money for our living expenses), a good ratio can be as little as 10% to as much as 80% of our income.
We recommend a minimum of 30% of your income if you are in your 20s, 35% to 40% in your 30s and 40s, and 20% to 25% in your 50s and 60s. Saving 0% of your personal income is not an option and would be a lifetime mistake. Likewise 90% would be excessive and could lead one to take certain investing risks that one couldn’t afford.
2. How much in Bonds, Stocks
An equally important question is how much of certain financial assets should we buy. It’s very important to understand that we will need to buy different financial assets to create a mix of investment. We call this mix an investment portfolio, and it has the purpose of creating diversification, that is creating diversity in the source of income of our financial assets. Because financial assets have different income signatures and different levels of risk, we can put them together in different fashion to achieve specific income targets for a much lower level of risk that would be possible with only one financial asset. What that means really is that mixing financial assets give us more value for our money. It’s a bit like a buy-1 get-2 promotion at the grocery store, you get a better deal. This is why diversification should never be neglected and the lack of diversification is a common investing mistake for many people.
The lack of diversification for buying financial assets is a major mistake that should be avoided at all costs. Putting 100% of your money into ONLY one financial asset is ALWAYS a fatal mistake.
3. What about Mutual Funds and other collective investment schemes
A mutual fund is a collective fund that holds a diversified portfolio of stocks and/or bonds. When we buy a mutual fund or even an Exchange Traded Fund (ETF), we are pooling our money together with other buyers/investors, and have a dedicated investment professional (portfolio manager) to manage collectively our financial assets. With a mutual fund we can invest our money without the time or the experience that are often required to manage efficiently financial assets. The real advantage of Mutual Funds is that they offer true diversification for our money, as they will actually hold an investment portfolio of assets that have different levels of income and risks, which is the very definition of diversification.
Theoretically, we should get a better return by giving our money to a Mutual Fund than we would if we were to choose and manage financial assets ourselves. In reality, they can be expensive in terms of management fees, and too often offer below average performance because of this. They also can be characterized by a lot of differentiating factors which make choosing a mutual fund a somewhat difficult task since there are about 1000s of them.
Technically, we could put 100% of our money into ONE mutual fund because a mutual fund already holds a diversified portfolio of assets. However, we do not recommend putting all of your money into a SINGLE mutual fund for the previously stated reasons.
Because they are portfolios of assets, we recommend buying between 5 and 10 mutual funds with different investment mandates. The right way to select mutual funds, however, is beyond the scope of this chapter, and you should solicite the service of an investment professional for selecting them in your design of an investment portfolio.
4. What about Alternative Investments (Options, Futures, FOREX, Gold…)
While many (if not most) investments fall into two categories: stocks or bonds, alternative financial assets represent the most complicated types of securities and investing strategies.
We don’t recommend investing in alternative assets if you have just learned how to invest money. These are complex assets with complex risk signatures, and they are definitely not for everyone. Their high-risk/high-reward characteristics make them much more speculative than plain old stocks and bonds. Yes, there is the opportunity for big profits, but they require some specialized knowledge that is beyond the scope of this chapter.
We need to avoid putting too much money into a single class of financial asset and we shouldn’t put our money into complex financial instruments if we don’t understand their source of returns and risks. It is simply basic common sense. However, we recommend putting money into a mix of stock and bond funds to seek diversification and improve the average risk-adjusted return of your investments.