What are 5 key investment decisions to make?
Few people have become wealthy without investing. Whether you are in the game already or starting out, it’s a plan to understand the back story of how you are making those five key investment decisions:
- Why invest?
- What to invest in?
- When is it good?
- Where is best?
- How long to hold on?
Checking how you personally answer those questions may determine whether you become a Buffett or a bean counter. As the great Warren Buffett himself said, “The best investment you can make is an investment in yourself. The more you learn, the more you’ll earn”.
You can get a general picture of yourself as an investor simply by asking vital-statistic questions and then a few uncomfortable ones; or by getting help from a professional or good investment software.
An investment guru or financial profiling software will convert information about you into an ‘investor risk profile’, laden with terms like risk tolerance, impulse control, emotional behaviour, and biases.
Yes, I saw you rolling your eyes there. But these aspects of your character affect the way you make investment decisions and are worth understanding as they will help you chart your investment roadmap.
Let us delve a little deeper.
Understanding yourself will help you make better investment decisions
1. The story of you
Where you are at in life, in age, stage, and earning, contributes to your ‘risk ability’ score – your current ability even to consider taking a financial risk.
The questions you or your advisor would ask are as follows:
- How old are you?
- Are you financially secure?
- Is your income a random event?
- Do you have assets and investments?
- Do you own a pallet bed and a dog?
- Is your debt a small cloud overhead or a nuclear eruption?
- Why do you want to invest – to buy a real bed, a house, for your retirement, to grow wealth, or to hold value in existing investments?
- These answers make up your risk ability, contributing 70% to your risk profile. Your risk ability serves as a clue as to how important these matters are and will aid in determining how much money you must invest. Setting your investment objective, how much cash flow you will need, and how long you plan to hold onto the investment before cashing it in.
2. You are unique!
Here are the types of questions you need to ask yourself about your character when it comes to investing.
- Are you a flat-out risk-taker, reasonably sensible, or that unique blend?
- Under what circumstances will you take a risk?
- Do you act on impulse, or stand back and watch and wait while your crazy friends leap at those ‘never to be repeated opportunities?
- How do you react to good or bad news?
- How do you respond in a crisis?
Let’s look at the following scenario as an example of situational response. You are going on holiday somewhere beautiful and new. You are driving to your destination and pass a sign to ‘AFRICA’S HIGHEST ZIPLINE!!!’.
Do you swerve left and fly down there without a second thought, blow half your holiday budget and go zipping? Do you slow down and give your passengers the ‘should we’ evil eye? Do you stop at the next lay-bye and contemplate all the pros and cons? Or do you pretend you didn’t see that sign and accelerate towards your holiday?
Test yourself for different risk situations (walking on coals, swimming with sharks etc.) to get a feeling for what constitutes safe and allowable risk versus unacceptable risk.
Ultimately, this will help compile your risk rating, which, together with your impulsivity rating, makes up your ‘risk willingness’ score. This score contributes the other 30% to your overall investor risk profile.
3. Me, biased?
We love to consider ourselves unbiased, but we collect prejudices like kids collect game cards.
Four of the many prejudices can derail intelligent planning.
- An anchoring bias shows up if you fixate on one aspect of an investment, like a hefty dividend, and you don’t read the rest of the stats on it.
- A self-control bias may pop up when you need instant gratification and consider selling an investment to buy a small island in the Indian Ocean.
- A regret aversion bias is when you do nothing to prevent being involved in a bad action replay of a historical event, like a sudden significant drop in a share price.
- And loss aversion bias is when you rush to take a risk to avoid a loss rather than to make a gain.
These biases are all rather subtle, but one needs to know them and try and avoid them.
4. Life will interfere
The state of the world at large or home and how you perceive it can also taint your investment decisions.
It is a good idea to be mood-aware because so many large and small dramas are lining up to make you grumpy. The big dramas like war, political skullduggery, illness, death, divorce, or losing your job can seriously taint your positivity.
A negative frame of mind can cause you to make irrational, impulsive investment decisions.
On the other hand, there will be those happy days when the war ends; a tyrant is toppled, you win a substantial contract, or you meet the love of your life – and then, who cares?
You may wish to toss some money to the wind, fly to the moon, sell your conservative shares and invest the lot in crypto—a little irrational and impulsive.
An investment advisor may suggest you avoid making any decisions on both these days and wait for a less exciting day. When the sun rises and sets without the state of your world being re-ordered.
5. What a day!
And never mind those crises of life, there is also the daily state of mind to factor into one’s investment calendar.
There will always be sunny-personality days and stormy ones, and these are increasingly anxiety-laden days.
After all, we live through a series of relationships, including partners, workers, generation XY and Z, in-laws, wasps and stinging nettles.
Understanding yourself is critical when you are investing money as a beginner.
Though it seems counter-intuitive, a positive state of mind has been associated with reasonably risky investment behaviour. There is the hope of adding more emotional rewards to the day.
On the other hand, a thunderous or anxiety-ridden mood is construed as heightening perceptions of danger and motivating one to avoid risk. This may be a good thing; at least you don’t worsen your day.
But again. You may want to make investment decisions on milder days when your mood is calm, and you can think more neutrally.