Individuals who want to invest in equities need to understand the risks associated with investing. Investing in shares and or stocks can be highly lucrative and can set you up for a bright financial future. However understanding the risks and benefits associated with buying shares is a crucial step for your education in the sector of investment.
What are the Risks of Investing?
Investing in shares, like any investment, comes with a certain amount of risk. Shares are often described as ‘high-risk asset classes’ when compared with other types of investments. The primary risk of investing in shares is that it can result in loss of capital. Unexpected events outside of your control or negative developments within the company can significantly affect share prices and the value of your portfolio. In saying that, this is not to scare you away from investing in shares, but merely a necessary understanding that all investors must have.
How Can I Reduce the Risk of Investing?
Today I’ve got to tell you that there are of course ways to reduce the risk associated with investing in shares. The following are common measures that investors should have in place to control the risks associated with buying shares. Keep in mind that this is general advice only and may not be suitable for your personal circumstances.
Diversify Your Portfolio
Not having all your eggs in one basket is a motto that strongly applies when it comes to buying shares. Probably the worst mistake a new investor can make is to not diversify adequately. Diversification refers to making sure an investor has shares in several companies of different industries/sectors/countires etc, thereby reducing the risk relative to the return. The degree of diversification is to the discretion of the investor. For example, if you decide to invest your entire portfolio in a single company dominated by the oil price, a collapse of the oil price will result in a collapse of your entire investment. Hence why it is important to diversify across different industries. Diversification on the share market can take many forms, for example investing in different sectors or different countries or both. For example, a well-diversified portfolio may have exposure to Telecommunications like National Media Group in Kenya, Materials, Financials like Bank of Africa, Bank of Baroda, Stanbic bank etc. Consumer Staples, Information Technology and International, just to name a few all listed on USE. The difficult part is knowing which sectors are most suitable and more importantly which companies within the sector are suited to your investment goals. One of the problems that often arises with diversification is that investors diversify at the cost of understanding their investments. Diversification is an important step when building your own portfolio.
Know What You Own and Know Why You Own It
It is vitally important to understand the company you are buying a share of. These days many investors forget that when they buy a share they are actually buying a part of a business and not just a digital ticker code. Without fully understanding the company’s operations, its financials or future outlook it is very hard to determine if it will be a good investment. The problem arises when you are interested in a firm, however you are unable to fully understand its business model. In order to diversify adequately, you may be forced to look outside your scope of understanding. If you don’t have the time or expertise on how to analyse companies a finance professional may come in useful. Having a professional equity analyst to contact and discuss the company will potentially lead to better investment decisions.
Investors should have along term Outlook
I always tell young investors who seek investment advise that different strategies can lead to success, however in my view, investors have the greatest chance to succeed in the stock market by taking on a long-term approach. An investor’s holding period (how long the investor plans to hold the shares) is crucial when it comes to investing. The shorter the investment horizon, the harder it is to predict the direction of the stock. Market fluctuations are regular, mostly unprovoked and are hard to predict. A common mistake among investors is to sell after a fall and buy after a rise. This results in complete absorption of the fall and missing out on the rise. The rule of thumb is don’t try and time the markets, have long term outlook and invest in good companies.
Try to control your emotions
Emotions are likely the number one challenge investors face on a day to day basis. Media speculation, your Barber’s stock tips, fear of missing out or running with the crowd are all factors that affect our emotions and in turn our investment decisions. Removing emotion from your investment decisions is easier said than done however having an investment strategy and the discipline to stick to it, can reduce the risk of emotional decision making.
It’s much better to buy a wonderful company at a fair price than a suitable company at a wonderful price. – Warren Buffet
The most important point to remember is that there is no secret to successful investing. The only rule is to buy great still developing companies and buy them at theright price because already developed companies have a less vacuum for expansion. This has over time been a proven way to achieve success on the stock market. Being aware of the risks and rewards of investing in the stock market is crucial for the decision making process. There are basic principles that allow you to minimise the risk of investing as outlined above, however there is no way to completely remove risk.
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Shares and Stocks are an element of a company’s ownership, but can they possibly allow you to walk out with a chair from its office?
Wherever you’ve travelled, had breakfast with friends, at business conferences and carried on business with companies that issue shares/stocks, you’ve probably heard of shares and how they are like owning a part of a company. If that’s true then you should be allowed to barge into a company’s office and leave with some desks and shelves the moment you’ve bought the share, right?
Well not really. That’s because you “owning a part of the company” is both true and not. The misleading bit is that the law treats the company or corporation as a separate entity or its own person that has separate property to the property of the shareholders. This limits their exposition in the case of a company going bankrupt.
So, unfortunately, you cannot walk out with a chair from the office if you’re a shareholder; however when you buy a share you purchase a portion of the company’s profits each year. If the company pays out dividends from its profits after a specific period of time you get a share in that.
Most corporations don’t pay dividends, but would rather keep all the profits and reinvest them in the company. But you still win from that, because that means higher profits for next year, which translates to higher share price. You can then sell the share if you’d like for profit and if not, you ought to leave your money there for it to return more profits in case the company is progressing positively.
You might’ve started thinking by now: Ok, so there is value in buying shares and stocks, but what about management? How can I personally influence the corporation so that I can control the direction where the price of my investment will go to?
Well, owning shares gives you voting power on the shareholder meetings. And if you own the majority of shares you get to appoint the board of directors. Their job is to increase the value of the company and that’s it.
A key point here is how you buy shares – either in the initial public offering (IPO) or from another shareholder in the secondary market. When a company issues stock it does so in exchange for cash which is used to grow the company. So issuing is like getting into debt for companies.
Hang on, what’s the difference between a loan and issuing stocks? Well, there is a substantial difference between stocks and treasury bonds. A shareholder is not a creditor. If a company goes bust and starts getting liquidated its creditors who get their money from the sale of the corporation’s assets first and with a priority. Shareholders get compensated with whatever’s left later on.
If the company doesn’t go bust, the bondholder’s return is simply the bond’s interest, which is fixed through time. On the other hand, a share’s payoff could be limitless in theory as a company’s profits could be as high as it makes them; So far history’s been on the side of shares. Stocks average 8-10% the past bazillion years, while bonds – just 5-7%.
How then can you create wealth through buying stocks?
This can be broken down into three different categories:
To hope for a growth in the company and the value of your shares and later sell them for a profit.
Receiving an income from your stocks in the form of dividends, as explained above some companies may not offer dividends but the biggest companies in the world often do because the profit is too much to simply invest it back into the business, therefore this money gets paid to shareholders in the form of dividends.
A combination of the above known as a balanced stock.
I have also received many questions from different portfolio holders on whether it is risky to buy stocks and shares in a developing or already developed company like Stanbic Bank, Kenya Airlines, Centum Investment, Uganda Clays among others. Well all that will be answered in my next article, just stay tuned in.
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Reveals the only way to make consistently smart investment decisions.
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Discover why you can never pay an advisor enough to put your interests before his own… and what to do about it.
Do you know the difference between a balance sheet and an income statement? Do you know the necessary due diligence steps to take before putting capital at risk on a new investment? Do you know the difference between investing and gambling and how it affects your profits?
Wondrously, the single biggest skill that can make or break your financial success isn’t taught in school. You can graduate with a three or four year degree and learn nothing about personal finance or investing.
I have seen doctors and attorneys opening their own practices without any clue how to read a financial statement. Business owners and investors remaining dangerously ignorant of the tax law.
Truthfully, financial literacy is the essential skill you must develop if your goal is to build wealth and enjoy financial security. There’s no alternative.
The best investment you can make is in yourself and your financial education. It’s the clear starting point to building wealth.
Why? Here are seven reasons:
Provides dividends for life that nobody can ever take from you.
Increases your earning potential.
Increases your return on investment.
Improves the quality of your life and finances.
Secures your retirement.
Defends your portfolio from unnecessary losses.
Provides peace of mind around money.
Now that’s a long list of advantages, but what about the disadvantages? Why doesn’t everyone master these immanent skills for investing and develop their financial literacy? Because it requires time and effort; and they’re too busy. That’s it. There are no other disadvantages.
If you’re willing to commit the time, you can have all the advantages that accrue to becoming financially literate. All you have to do is put out the effort, and a lifetime of benefits is yours for the taking.
“Invest in yourself, in your education. There’s nothing better.”– Sylvia Porter
It’s one of those “duh-obvious” decisions that’s easy to understand, but hard to live. After all, what do you prefer: a little bit of effort now in exchange for a lifetime of financial security, or a little bit of procrastination and retract now in exchange for a lifetime of financial mediocrity? Not a very difficult decision, but surprisingly few people make the wise choice.
Financial education is one of the great bargains in life: it costs little, risks nothing, and yields huge rewards. It’s the best investment you can make. The sooner you get it, the more it’ll be worth to you.
The longer you wait, the more it’ll cost you. Which path will you choose? Below, we’ll examine each of the seven reasons why financial education is your best investment so that you make the profitable choice.
Most Investment Advice Is a Dangerous Half-Truth
Aren’t you tired of all the financial and investment experts with their conflicting investment advice?
One expert says pay down all your debt because it’s bad, and another says leverage up with good debt to build wealth.
One expert says the stock market is the key to riches, and another expert tells you more millionaires come from real estate than any other source.
One expert says diversify to reduce risk, and another expert calls it di-worsefying that insures mediocre results.
How is a person supposed to learn how to invest money when the supposed experts can’t even agree? It’s enough to make you go insane! Who can you trust?
Each authority speaks as if there is one and only one right answer, yet each financial expert offers differing and often conflicting investment advice. It makes no sense! It’s frustrating. It drives me wild when supposed financial experts speak in over-simplified, dogmatic statements as if they have the one right answer.
True experts know that most financial truths are more subtle and complex, so they don’t insult your intelligence with over-simplified, sound-bite investment advice. Even the most basic investment ideas such as buy and hold stocks for the long term are too complex to be adequately explained in a media sound-bite or brief article.
The reality is each item of conflicting investment advice above is partially true and partially false – depending on the situation. There are times when it makes sense to leverage up with good debt, and there are other situations where it can be equally correct to pay off existing debt. There are times when “buy and hold stocks for the long term” is a sound strategy, and there are other times when the risk isn’t justified by the reward. Each is a dangerous half-truth.
“Education is a progressive discovery of our own ignorance.”– Will Durant
Three months ago i told one of my clients that one reason financial education is necessary is to understand the subtle shades of gray hiding behind all the investment half-truths you hear. First of all, how else are you going to process this information into profitable investment decisions? You must know when a conditional-truth is applicable and when it should be disregarded, because it can get you in financial trouble.
For example, do you understand when buy and hold is a smart investment strategy, and when the risk is not justified by the reward? Do you know when to leverage yourself with debt to grow wealth, and when it makes sense to pay off debt? What is the best wealth building vehicle – paper assets, business, or real estate – and why?
Questions like these can make or break your financial future. Learning the presumptions and reasons behind investment half-truths is one reason why financial education is necessary. It’s the only way you can know who is right, who is wrong, and why in a world of conflicted and contradictory investment advice.
One Size Doesn’t Fit All Investors
Despite what all the investment experts selling seminars and courses want you to believe, there aren’t any secrets to investing. To paraphrase John Bogle of Vanguard Investment fame, “The secret is there are no secrets.”
In a leadership class (Honours College) at Uganda Christian University in 2018 I once shared with scholars that; there are many different ways to invest profitably, and there are many sources where you can learn the information. There’s nothing new under the sun, and no marketer has a corner on teaching any particular type of investment strategy.
If you don’t want to pay a high-priced guru thousands for his boot camp or seminar, then you can assumably find very similar information for less than a hundred dollars at your local library or online bookstore. What you can’t get from a bookstore — or most gurus — is the real key to financial security: figuring out which of the many available investment strategies will work for your personal situation. Their investment advice is generic, but you need it personalized.
Not all investment strategies are appropriate for all people, but there’s one right solution for you. Your job is to find it so that you can achieve financial security. You’re a unique individual with your own skills, background, experiences, and outlook on life.
You have a risk tolerance unique to you and druthers, time frames, and goals that are different from everyone else’s. What are the odds that a weekend investment seminar or week-long boot camp teaching one specific investment technique is going to be the right fit for your unique needs? It makes no sense.
The hidden assumption behind most investor education is “one size fits all.” It doesn’t work with clothes, relationships, or sunglasses, and it certainly doesn’t work with investment strategy. One size does not fit all.
“If you want to be truly successful invest in yourself to get the knowledge you need to find your unique factor. When you find it and focus on it and persevere your success will blossom.”– Sidney Madwed
Each person has a unique gift to bring to the world, and financial success results from an investment plan that capitalizes on that uniqueness. How you retire early and wealthy is going to be different from everyone else you talk to or associate with.
That’s why prepackaged advice, investment seminars, and generic computer solutions that spew static financial “truths” can never measure up to personalized education that helps you find your own truth.
Consequently, the second reason for the necessity of financial education is so that you can learn enough about yourself and the various investment strategies in existence to develop a wealth building solution custom fitted to your unique skills, values, and resources.
If you don’t educate yourself to do it, nobody else will.
How to Overcome the Conflicts of Interest in Investment Advice
The only person 100% committed to your pocketbook is you. Everyone else has a conflict of interest. No less an authority than Alan Greenspan told Congress that:
“For an increasingly complex financial system to function effectively, widespread dissemination of timely financial and other relevant information among educated market participants is essential if they are to make the type of informed judgments that promote their ownwell-being.”
Greenspan also spoke about the need for Americans to better educate themselves about managing their finances and to promote greater financial education for children in the school system. He stated, “Financial literacy can help prevent younger people from making poor financial decisions that can take years to overcome.”
You must learn how to invest your money because no one will ever care about it as much as you do. Nobody else is making financial decisions in your life with zero conflict of interest except you. You are the only investment advisor for your portfolio that solely has your best interests at heart.
Everyone else is in business to serve their best interests. Avoiding conflicts of interest by being skilled enough to sort investment fact from fiction is the third reason why financial education is necessary.
You Can Delegate Authority, But You Can’t Delegate Responsibility
Well, many people want to believe their advisors will take care of the big financial issues like retirement, college savings, and wealth planning for them. Just delegate the issues to a professional advisor, and don’t bother learning for yourself. They’ll take care of it.
Drivel!
Whether you hire financial experts or invest independently, you’re still responsible for your investment results. Each choice is a decision you make; therefore, you’re responsible. You decide which investment expert to hire, and you decide which investment to buy.
If you don’t like your investment results, there is no-one except you to blame. You can’t delegate the responsibility, even if you delegate the authority.
“The difference between success and failure in the stock market is education.”– Bill Griffeth, CNBC Anchor
The only way to make consistently smart investment decisions is if you learn what works, what doesn’t, and why.
If your investment decisions aren’t based on knowledge, then what are they based on – salesman’s charisma, speaker’s charm, media sound-bites, trust, or blind faith? None of these are a tried-and-true prescription for investor success. There’s no substitute for knowledge.
It’s incongruous to own self-responsibility in your mind for your financial future, yet not take action by educating yourself on how to make smart investment decisions. Anything less is irresponsible. Prioritizing your financial education is how you become self-responsible for your financial future. It’s the fourth reason financial education is necessary.
Your Financial Intelligence Compounds Like Money
It’s critically important that your financial intelligence grow at least as fast as your portfolio. Why?
Because there is nothing more financially dangerous than a million dollars worth of investment decisions being made with a thousand dollars worth of financial intelligence.
“Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do, when it ought to be done, whether you like it or not; it is the first lesson that ought to be learned; and however early a man’s training begins, it is probably the last lesson that he learns thoroughly.”– Thomas H. Huxley
Your financial intelligence acts as a ceiling that restricts the growth of your wealth. As you raise your financial intelligence, you raise the ceiling on what’s financially possible for you.
Your financial intelligence sets the context for your investment success – or lack thereof.
Your return on investment should improve as you learn how to invest more continually and control losses when the inevitable mistakes occur. That translates into more dollars in your pocket and greater financial security.
A little known fact about financial intelligence is it grows and compounds just like money. The effect is multiplicative – not additive. Each new tidbit of information connects to all the other knowledge which multiplies.
It doesn’t just add up, but it grows geometrically by multiplying. Your goal should be to make regular deposits every week into your financial intelligence account, just like you make monthly deposits into your investment accounts.
When you do this, your financial intelligence will multiply and grow ahead of the growth in your investment accounts to help create a lifetime of financial security.
Financial Intelligence Is the One Investment You Can Never Lose
Financial education is like an annuity. It’s a one-time investment that pays dividends for the rest of your life.
People can steal your money, but no one can ever take your financial education from you. Once you know it, you can never un-know it. The sooner you seek investor education, the sooner you can begin reaping the rewards.
The longer you enjoy financial literacy, the more value you will get from it. Every year it compounds profits in your portfolio. Why not start learning how to invest and manage your personal finances today?
True Freedom and Independence Requires Financial Intelligence
Needing others to make financial decisions for you is dependence. Regardless of the amount of money you have, you’ll never be financially independent or secure as long as you depend on someone else to manage your money.
You can’t experience true freedom if you’re dependent on someone else’s experience and knowledge for your financial well-being.
The world is littered with people who built vast fortunes and lost it all because of their own financial ignorance.
Lacking financial intelligence is the opposite of financial security – no matter how much money you have. Choosing the path of financial intelligence, where you learn to make decisions independent of other people’s advice, leads to investment wisdom.
This allows you to independently sort all the divergent opinions with confidence and decide what’s uniquely true for you and your portfolio. The alternative is to remain permanently dependent on all the conflicting and confusing opinions offered up as expertise by others, and play a guessing game as to what’s true for you.
Financial education teaches you how to fish so that you never have to be dependent on another person to give you a fish again. Financial education teaches financial independence.
Financial Education Is Your Best Investment
So what should you do now? The answer is simple: commit to growing your financial literacy with a process of recurring improvement by beginning to learn today.
Rome wasn’t built in a day and neither is financial intelligence. You have to start somewhere – wherever you are right now – and fortunately, success is a learnable skill.
If you work on yourself and study regularly, the reward for persistence can be financial freedom.
There will never be a better time than now to learn and prepare so that all these benefits can be yours:
Financial education will teach you how to sort all the conflicting investment advice so that you know how to manage your way through a world filled with investment half-truths.
Financial education will help you build a wealth plan custom fitted to your individual needs.
Financial education will help you negotiate the conflicts of interest inherent in investment advice.
Financial education is how you demonstrate self-responsibility for your financial security.
Financial education is how you raise the ceiling on your financial future by raising your financial intelligence.
Financial education is like an annuity – it pays dividends for the rest of your life, and nobody can ever take it from you.
Financial education is the foundation on which true financial independence stands.
Financial education is a long term approach to wealth. It builds consummation on several levels by growing your knowledge, experience, and portfolio simultaneously so that you can retire early and wealthy with security and peace of mind.
Financial education is your best investment, and the only thing keeping you from enjoying all the benefits of smarter investing is… you.
If you aren’t clear on the tangible dollars and cents value of financial education in your life, then here is a quick and fun exercise to prove it to yourself.
Go to this free retirement calculator and input your financial information as best you know it today, and print out the results. Don’t worry about accuracy: just do the best you can.
Then increase your savings rate and investment return by 20% (i.e. from 10% to 12% investment return or from $400 saved per month to $480), and notice the dramatic change in results when compounded over your expected lifetime.
That’s an example of the potential cash value of financial literacy. It’s literally worth a fortune. It can mean the difference between financial security and flipping burgers in your old age.
So what are you going to do about it? What actions are you going to take today? If you aren’t motivated to make a change, then all I can say is I walked the talk and it literally made me a fortune.
I’m a big believer in financial education because I know the difference it made and it’s still making in my life. I hope you’ll join me and do the same. Nobody said it better than this:
“If you think (financial) education is expensive, try ignorance.”– Andy McIntyre
Have you ever thought of Making Your Money Hard to Reach as a young investor? I’ve got your back today
A pile of savings that is serene and pain-free to reach is an easy solution to life’s troubles.
And to us that’s a bad thing, right?
Your car breaks and you use your savings to buy a new one. You get laid off and use your savings to carry you through until the perfect dream job arrives. Life throws you curve balls and tantrums and savings without barriers to protect them are an easy target for solution.
That is why I love the government-aided retirement plans with all the difficult rules and penalties you must overcome to access your money prior to retiring. These obstacles provide a measure of discipline for those who inherently deficient this life skill.
Even if you have the discipline of a celibate monk, the rules and penalties provide a formidable barrier for your inescapable moments of human weakness.
The rule is simple: When you build a nest egg for yourself, don’t raid it. Never borrow money from it for contemporaneous lifestyle and don’t spend a dime of it until after you retire.
Just relax and let it grow and grow until you are financially free. I know this is easy to understand but hard to live by.
That is why many quick-witted investors place their retirement money in hard to access investments like real estate or government-aided, tax-deferred retirement plans. This fortifies discipline by making the money just difficult enough to reach that you don’t raid your own nest egg when those inescapable “emergencies” arrive.
Retirement plans allow you to compound your money while deferring or avoiding taxes entirely (depending on the plan and your circumstances), while real estate provides tax savings and deferral through depreciation deductions and 1031 exchanges.
After thorough research, I got to realise that building wealth for retirement is not just about how much money you make, but about how much money you keep. That is why tax savings is a crucial element of your plan.
Conveniently, both real estate and government-aided retirement plans offer both tax savings and barriers to access, thus fortifying discipline while enhancing savings.
As a young investor, you would be wise to put these tools to your advantage. Are you in?
Autonomy to Financial Freedom 