Everyone should have an investment or savings strategy to help in fulfilling their personal goals whatever they may be - retirement, purchase of a home, children's education. The strategy should be easy to understand and not require constant monitoring. The savings products chosen to carry out the strategy should be easily understood. The following should be considered when setting such a strategy:
When Will the Funds be Needed?
The answer to this question is your Time Horizon. It is directly related to the reason you are saving in the first place. If saving for a child's education, the time will be known and quite specific. If retirement is the goal, the time horizon may be longer and have to be estimated. Whatever the reason for investing, the Time Horizon should be realistic and reflect your personal circumstances.
Peace of Mind
This is usually referred to as Risk Tolerance. Each individual investor has a unique comfort level when dealing with investment risk. For many people, the ability to sleep at night outweighs the potential of higher investment returns associated with more aggressive investments.
The length of time that savings remain invested has a major impact on the final amount accumulated. The primary reason is compound growth. Compounding may be thought of as income earned on both the original savings amount and previously earned investment income. As the amount of previously earned investment income increases over time, the compounding effect becomes more and more significant. The acceleration in savings growth that results can add up to thousands of dollars over the long term. This is especially valuable when saving for long-term goals such as retirement. To realize the advantage of compounding, all that is required is the discipline to start now rather than later.
Regular automatic contributions are an excellent way to accumulate savings by ensuring that your financial goals maintain their priority. It is usually more difficult to save for an annual lump-sum purchase than to invest a little at a time. Similarly, the strategy to regularly put away "whatever is left over" can produce disappointing results - even with the best of intentions!
Investing at regular intervals provides an added benefit when purchasing equity investments. Because stock markets move up and down over time, there is an undesirable possibility of making a lump-sum investment when the market is at a high level. Investing smaller amounts more frequently will reduce risk and usually results in a lower average cost per unit. This is achieved through what is often referred to as "dollar cost averaging". A fixed regular contribution amount will purchase more units when markets are low, and fewer units when markets are high. Provided the market gains in value over the long term, dollar cost averaging can transform short-term volatility into an advantage for the investor. This principle also applies to investments in bonds, since interest rates also fluctuate over time.
Invest for the Long Term
If a financial goal involves a long time horizon, it only makes sense to take a long-term view of the investments used to achieve that goal. With a vast amount of information available on recent events and day-to-day market fluctuations, discipline is often required to stick with the original investment strategy selected. Acting on the impulse to "do something" greatly increases the chance of buying or selling an investment at the wrong time. This is especially important when investing in stock markets (equities). Equities have historically provided higher returns OVER THE LONG TERM than fixed interest investments like bonds and GIC's. However, stock markets can be quite volatile. This should come as no surprise if you understand the risk/return trade-off. If you are not committed to equities for a long period, the additional returns expected for taking on added risk may not materialize.
The Importance of Diversification
Diversification in the investment world is an application of the old principle "don't put all of your eggs in one basket". A well-designed investment strategy will usually contain a mix of investments from each of the three main asset classes - Cash, Fixed Income, and Equities. Diversification by asset class allows you to take advantage of the primary benefits of each. Available investments include daily interest savings accounts for liquidity and safety, guaranteed investment accounts for guaranteed income and safety, and equity funds for dividends and capital growth. Your time horizon and risk tolerance are key factors to be considered when selecting an optimal asset mix.
Within the Fixed Income and Equity asset classes, diversification can be achieved easily and at a low cost by purchasing units of a mutual or segregated fund. Since investment funds typically contain a number of securities issued by many different entities, the "business-specific" risk associated with an investment in a single company's stock or bond can be greatly reduced.
For investors who wish to assume the risk of investing in equities, allocating a portion of those funds to foreign investments may be desirable, as it further increases investment diversification. Individuals who invest all of their savings in Canada are ignoring 97% of the world's investment opportunities. Canada represents less than 3% of the world's stock markets, and many of the largest and most attractive companies are based elsewhere.
Developing a Personal Investment Strategy
A GINIM Advisor can assist you in developing an effective yet relatively simple investment strategy using an approach that considers your Time Horizon and Risk Tolerance.