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“A campaign is about defining who you are – your vision and your opponent’s vision.” ~Donna Brazile
This is a guest article from D.J. Raymond
One of the first things that beginner investors should do before investing one dollar is to define themselves as an investor. All too often new investors enter the markets with a pocket full of money and no clear sense of purpose or direction for their investment goals. This is a recipe for financial disaster; still it happens every day, and in nearly every market.
Let’s start with defining what an investment is. An investment is typically an asset, such as a stock or a bond, or a mutual fund, then investor buys in order to build wealth over time. The investment value will rise or fall based on number of factors, from supply and demand the state of the overall economy. The intention of the investor is to sell the investment later at a higher price. That sounds simple, does it not? An investment is not a lottery ticket. While that may seem like a foolish comparison, the fact is there are many investors who trade the stock market just like they are buying a daily lottery ticket, hoping that their numbers come in. Now that we have hopefully established what investments are and what investments are not, how do you determine what type of investor you are? There are some foundational principles to investing that you need to consider. They are risk and return, volatility, and risk tolerance. As you read through these factors, try to find a place within these factors where you are comfortable.
Risk is a small word but can have serious implications to the beginning investor. Risk can be defined as the uncertainty of investments return. Everyone remembers passbook savings accounts. You made deposits and you are guaranteed a return. Therefore there is no risk. On the other hand investing the same money in a particular stock carries with it a measure of risk. Depending on the performance of the stock, it could double in value or it could become absolutely worthless. Over time volatility would determine how much the investment fluctuates. Risk and volatility work together. The higher the risk of investment, generally the higher the volatility and the potential for return. As an investor you fit somewhere within these parameters. You may be content with a savings account with a guaranteed return or you may want to risk your investment on an investing instrument with the potential for more return. No one person can determine who you are as an investor better than yourself.
Defining risk tolerance in investing is where you will discover where you fit in how you define yourself as an investor. Risk tolerance essentially is the amount of risk that you, personally, are comfortable accepting in your investments. Let’s assume you have $10,000 to invest right now. You can invest the $10,000 anyway you want. You may choose a high-flayer stock with the potential of doubling your money quickly. Perhaps you would rather invest in a mutual fund that over the course of the last five years has returned 9% to its investors. It is time for decision. Which investment did you choose?Determining your risk tolerance also involves your time horizon for investing. The longer your time investing horizon the greater the risk you can assume because short-term changes in the investment’s value won’t affect you. If you invest on a shorter time frame you will need to adjust the type of investment accordingly. If you are investing time line is 10 years or more you can accept a higher risk tolerance, and would generally invest in stocks. A more moderate risk tolerance position would likely invest in stocks and cash equivalents such as certificates of deposit, and investing in bonds.
No one likes to lose money. Everyone has a personal response to risk. Are you the type of person that avoids risk in every day life and worries easily? If so it might be best for you to avoid the higher risk investments. Your returns may be lower, but you will get the benefit of lower volatility and much less stress.
Conversely if you enjoy risk and you don’t worry, you will be comfortable investing in growth stocks almost exclusively, assuming you have a longer time horizon in which to invest.Defining yourself as an investor has as much to do with your own personality as it does with any other factor. Your age and investing time horizon will help you determine who you are as an investor. However, nothing will help you determine who you are as an investor as your own personality.
DJ Raymond is a veteran individual investor and frequently writes about investing and finance. His passion is for teaching and informing on how investment markets work and how to make them work for you.