With base rates remaining at record lows, investment is the only way to get a decent return on your savings. Even if you intend just to pass your capital to a broker and let them get on with it, it’s important to understand even a little about investment.
Here are five reasons why.
Basic investments are all most people need
Most people needn’t get involved in complex financial securities and timing the market. Basic, easy to understand investments can deliver the relatively low-risk, relatively modest returns the majority of private investors want. Complexity should be left to the professional investment bankers.
Index funds – mutual funds tracked to a market index like the S&P 500 or FTSE 100 – are a good example. Investments are made to reflect the index – so if 8% of the FTSE 100 is in BP, 8% of the index fund will be too. Investors profit and lose from movements in the entire market, rather than individual assets, in a well-diversified fund.
As they aren’t actively managed, index funds are very low-cost and can be bought directly through discount brokerages. The up-shot being that with a little knowledge, you could save yourself a lot of money by bypassing third party advice.
Choosing the right advice
If you’re looking for something a little more complex, you need to know about investment so you can pick the right broker. Not all brokers are made equal and you need to know enough to pick a snake-oil salesman from the genuine article.
The wrong broker may not work in your interest. Brokers generate a commission every time they buy and sell stocks, so unscrupulous types may trade excessively – costing you money without generating profit. Aside from the commission, lots of trades in a short period is not generally a good strategy. You need to be able to spot this.
Investment advisers receive no commission and are required by law to act in your interests. The downside is that they command high hourly fees, so it’s just as important to pick a good adviser from a bad one.
At the very least you need to understand what fees you’re paying, for what, and why. Only then can you assess their worth.
Keeping an eye on your portfolio
Even with a trustworthy broker managing your money you need to keep an eye on your portfolio. And to do any good, you need to understand what’s happening with it.
You may have a portfolio manager who considers you small-fry and is inattentive to your investments. You may disagree with the investments they’re making on your behalf. Plenty of professionals make mistakes – the dot-com boom of the late 90s is evidence enough.
An understanding of risk will help you ensure your broker isn’t taking more risk than you’re comfortable with, or enough to achieve your goals. If you want to take it slow and steady, you need to be sure your broker isn’t playing fast and loose with your cash. Conversely, if you need money sooner, you may need to encourage them to be more aggressive. Without context, you won’t know what either looks like.
There are also plenty of investment scams out there – remember Bernie Madoff – and you’ll need some level of understanding to protect yourself against crooks.
Bottom line is it’s your money, you need to take responsibility for it and that means understanding what’s happening to it.
Understanding is the key to staying calm
Market trading can be a fraught experience, particularly when investing your own capital. That money is your retirement, your children’s inheritance. It’s easy to get spooked, particularly if you check your stocks too often.
If you don’t understand long-term market cycles you may be prone to panic (and a huge bill with your investment adviser for anxious calls). Even worse, if managing your own portfolio, ignorance could be the path to disaster: chasing market fluctuations (buying high and selling low), failing to diversify (putting it all in one company or sector) and panic selling.
A basic knowledge of investment will help you to not get frightened by normal market changes and protect you against short-termism.
Understanding your investments is the best path to success
If you want to take a more hands-on approach to your portfolio, some of the most successful investors of all time subscribe to this credo. Invest in businesses you understand. You can use your knowledge of the industry to foresee problems or successes and invest accordingly.
At the very least, it’s worth sticking to investments you’re comfortable with. If you don’t understand derivatives and complex debt securities – stay away from them. Understanding is as much about knowing your limits as it is knowledge.
Not everyone who invests aspires to be the toast of Wall Street. But even a little knowledge will go a long way to protecting your investments.