Establishing safeguards before embarking on an investment journey
Investing comes with its share of risks, which can sometimes lead to partial or total loss of your savings. Assessing your financial situation and establishing safeguards before embarking on an investment journey is essential.
The decision to invest should hinge on your financial goals. Are you looking to increase your wealth, generate regular income or both? Do you have a specific growth target for your savings or a minimum required income?
Generally, investments require a minimum commitment of five years to overcome market fluctuations. This is especially important if you’re nearing retirement. Clearly defined goals will guide your risk-taking limits to achieve your desired outcomes.
Investment considerations for different life goals
Here are some common life goals and related investment considerations:
Property Purchase: If you intend to buy within the next five years, consider keeping your savings in a Cash Individual Savings Account (ISA) or Lifetime ISA. If you’ve got a longer timeline and it’s your first home, an investment Lifetime ISA might be worth considering for government bonuses.
Marriage Plans: Cash savings might be more suitable unless you’re tying the knot five years from now.
Child’s University Fees: A Junior ISA can be a good option as the money will have up to 18 years to withstand market volatility.
Retirement: Making additional voluntary contributions to your pension could only be beneficial if you’re at risk of exceeding your Annual Allowance.
Assess your debt situation
Before you invest, ensure you are in control of any debts. Aim to reduce any borrowing to manageable levels or clear all debt before investing, especially if the interest payments on your debt will likely outweigh potential investment returns. Mortgages and certain types of student debt might be exceptions if the interest rates are low.
Do you have a financial safety net? Before taking investment risks, you should have emergency savings in place. A general rule of thumb is to save up at least three to six months’ salary before investing. Consider upcoming expenses, too, as quick withdrawals from investments could result in losses.
Protecting your future
Ensure you’re safeguarded against prolonged work absences. Review your employer’s sick-pay scheme and consider income protection insurance if you’re self-employed. Other insurance, like critical illness cover or life insurance, is essential if you have a mortgage or dependents.
Understanding investment risks
Comprehending the risks involved in investing and deciding your risk tolerance level is key. Even with a long investment horizon and ample cash reserves, high-risk investments may not suit you if market volatility keeps you awake at night. Understanding what you’re investing in is essential to evaluate the associated risks accurately.
While some investments, like corporate and government bonds, are considered less risky, no investment is entirely risk-free. For instance, if a corporate bond issuer goes bankrupt, they won’t be able to pay interest or repay the loan, rendering the bond worthless. The risk level of a bond largely depends on the issuer’s creditworthiness, indicated by a credit rating.
Balancing risk and return
If you aim to boost your potential returns, you’ll likely need to accept an additional layer of risk. Hence, it’s crucial to diversify your portfolio with a mix of investments that align with your risk tolerance.