5 questions to answer before you start investing

By Larissa Fernand |  24-11-20 | 
 

Meagre experience in the financial world should not hold you back from investing. Having said that, answering a few essential questions will help you build a strong foundation.

Q 1: Why are you investing?

If you want to be disciplined in your savings, you have to figure out why you are saving. When a goal is years or even decades away, it is tough to stay motivated and not “live in the moment”. Understanding why you are saving money is pivotal to staying on track.

Someone mentioned to me that his biggest fear is being old and broke, and that keeps him motivated to save for retirement. I don’t encourage negative imagery, so I would rather imagine myself happy and secure and comfortable in retirement and use that image to keep me motivated.

Billionaire Mark Cuban explained how he lived an extremely frugal life when he was young. He had five roommates in an apartment with 3 beds; he slept on the couch or on the floor. He worked as a bartender and gave dance classes. He lived on macaroni and cheese, and mustard and ketchup sandwiches. He drove a cheap car. But his frugality was a conscious decision. He was determined to save money because he had a “why”. His motivation was that he wanted to travel, have fun, and party like a rock star.

Q 2: Is it the right time to invest?

It is always the right time to invest. And yet, it may not be.

The first would be to look at your debt. Instead of investing, it may make more sense to pay down existing debt. Falling behind with debt is a huge roadblock to financial freedom. When you service your credit card debt of around 24% per annum, be extremely mindful of the fact that this debt costs you a lot more than you can ever earn elsewhere. Even if you are servicing a much cheaper loan – say 12% per annum, once you clear it there is an immediate return there. Please read How to get out of debt.

What do you do when life throws you a curveball? Or bowls you a googly? Find yourself unemployed. A medical emergency. Unprecedented travel to visit a relative who met with an accident. Urgent and extensive repair needed on the house.

When the unexpected takes place, you can use your credit card or take a personal loan or borrow from family and friends. But eventually, all these loans have to be squared off. The danger of not having an Emergency Fund is that you will either get into debt, or you will tap into your existing investments, which will put your goals in jeopardy. Not to mention the fact that you may be forced to sell your investments at a bad time and incur a loss, in addition to tax implications.

Please read 4 questions on Emergency Funds answered and get it in place before you start investing. Or, at least start creating one and give yourself a time frame of a few months to set it in place.

Q 3: How much must you invest?

This one is tricky because everyone’s situation is different. An acquaintance earns extremely well. I naturally assumed that he is saving a huge amount. He recently informed me that he is servicing a home loan for the house his parents reside in. In addition, he pays rent for his place of residence. He is now doing an Executive MBA for working professionals from a premier institute for which he has to take an education loan as the total cost amounts to Rs 36 lakh. He barely manages to save.

While my advice would be to save as much as you can it is vague. If you don’t know where to start, consider the 50/30/20 rule of thumb. Split your income into three categories:

  • 50% on 'needs' (rent, living expenses, school fees for the children, electricity bill, groceries)
  • 30% on 'wants' (things you want but don't necessarily need)
  • 20% on 'savings'

Use this as a base. Fine tune it to your circumstances.

Q 4: Where must you invest?

Investing must make sense for your situation. Creating a portfolio that is consistent with your ability as an investor to take on risk and keeping in mind your time frame, is a complicated exercise.

If you are saving for the near term, then you should avoid equity. If it is a long-term goal, you must consider equity.

It is important to consider not only risk preference (i.e., how I would feel or react based on market performance), but also risk capacity (i.e., how much risk should I take given my resources and financial situation).

Based on the above, you can arrive at the appropriate asset allocation; how much to invest in equity and fixed-income investments.

“For example, if the investor is targeting an overall equity allocation of 60% of assets, they must determine how to invest in equities (i.e., for a given risk level)”, says Paul Kaplan, Morningstar’s director of research. The investor could choose to invest entirely in domestic equities or have some global exposure. Within domestic equities, one can consider large caps or a multi-cap exposure.

It would help to take professional advice here.

Q 5: Are you investing in yourself?

You need to nurture your earning power. Staying employed is one of the best things that you can do for the long-term health of your financial plan. In a changing job market, it is your skills that will help you adapt.

You don’t need advanced degrees. Keep learning. Keep reading. Educate yourself. Develop skills. Enhance your abilities. Sharpen your insights. That’s what’s going to get you ahead.

Practice efficient allocation of human capital: Time, Money, Energy, Talent. How can you put each to efficient use? Which relationships are worth investing into, and which are a drain? How can you develop your human capital today?

Investing in yourself is one investment that supersedes all others because it is your lifetime earnings power. Look at ROI – Return on Investment, from all facets. You are your biggest asset.

Investment Involves Risk of Loss.

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