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Getting Started : Knowing Yourself

Some of you may have the feeling that you don't have enough money to make your dreams come true and why not, there are only two ways to earn money and they are:

  • You work hard and you get paid for it.
  • You make your money work hard and you get paid in return.

Investing is a way of making your money work harder for you. Before, we get into discussing about investing; first, you need to know yourself.

A much learned man has said, "The ability to ask the right question is more than half the battle of finding the answer". So, for you as an investor, your job is much easier as you need to ask only three fundamental questions.

So, the three fundamental questions are

  • How much money do you need?
  • By when do you want this money?
  • How much downside are you willing to take to earn the money you need?

The first two questions talk about your gain and we know in this world there can be no gain without some pain. So, the third question is about your ability to take some heartburn.

Industry pundits have got jazzier terms for all the three fundamental questions.

  • "How much money do you need?" is called Future Planning
  • "By when do you want this money?" is called Time Horizon
  • "How much downside are you willing to take to earn the money you need?" is called Risk Level

Future Planning:

If you don't sit down and decide exactly what your financial goals are, you will always be in the stressful state of 'needing more' and you won't know how much is enough.

So, the first thing you need to determine is how much you really need to pay for all the expenses in your life (expenses can be buying a house, a new car, a foreign exotic holiday, your children's education fees or your day to day expenses) , and to retire in a relatively comfortable state. The next section on 'Setting your Goals' delves deeper into future planning.

Time Horizon

The next question you have to ask yourself is this:

By when do I need this money?

The rule is this: the longer the time frame that you have for your investments, the more likely you are to make positive returns. Also, you can afford to take on more risks. If you are pressed to make a quick buck in a very short time, chances are you won't do very well. This is because markets are unpredictable. Whilst it is true that over the long term, mutual funds have given great returns, in the short term, prices may fluctuate.

If you are caught with prices falling, and you do not have the luxury to wait it out, then you would have to sell at a loss.

Mutual Funds are medium- to long-term investment instruments. It makes use of the biggest ally of all long term investors, and that is TIME. If you have TIME on your side, you can ride out any dips in market cycles and use those dips to your advantage.

So, at least some of your money should be invested for longer horizons.

Risk Level

Different mutual funds have different levels of risk. There are those that are invested in 'fixed income' instruments, such as bonds, which are relatively low in risk, and have very little volatility. Then, there are those that are invested in 'growth sectors', which are stocks of companies in high growth industries. These mutual funds can be quite volatile and prices can rise and fall dramatically.

Risk is typically represented by volatility in prices. If prices swing quite a bit, it means that there is a possibility that you might have bought at a higher point, and then the price starts to swing downwards. In our fund lists, you can check the risk rating of different mutual funds, which gives you an indication of risk.

Of course, typically, the higher the risk of the fund, the higher potential returns it might deliver. So the more risk you are willing to take, the better your returns can be.

Think you are the conservative type that can stomach very little risk? Well, the truth is that you can probably handle a lot more risk than you think. You simply have to recognise the dangers that exist, and learn some easy strategies to protect yourself.

To find out your risk profile, read 'Risk Taking'.

Next : Knowing your committments