Investing Beginners:  Investing is All about Managing Risks and Returns

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Successful investing requires three factors in combination: knowledge, experience and the ability to control one’s emotions.  The first factor can be achieved by immersing yourself into the topic, reading everything you can to familiarize yourself with terms and techniques of the craft.  Once you enroll in a class, you can move toward the second objective by being mentored by a professional. 

The last factor, controlling your emotions, is perhaps the most important one and requires more introspection on your part to determine what type of investor that you want to be.  If you are losing sleep at night with anxiety over your investments, then perhaps a modification in your style or type of investing regimen is in order.  The last factor has more to do with your personality, your individual investment objectives, and your tolerance for risk.

Investors generally fall into two different types: the ones who gather information and buy and hold for long periods of time, and the other ones that prefer a more active trading style, moving in and out of the market to record short-term gains.  It is recommended that you match your personality type to your investing style to get the best results. 

Investing for the most part is all about managing risk. It just so happens that the different types of investment vehicles can be arranged based on their individual risk profiles, as depicted in the diagram below:

As you move up the pyramid, the risk profile increases.  Generally, the reason a person will take on a higher level of risk is for a greater potential for reward in the form of a higher return, at least enough to justify taking the risk in the first place.  As you move down the pyramid, your choices become safer, but with lower rates of return.  A prudent investor understands that all investments involve risk.  Do not invest in vehicles that you do not understand completely.  Many brokers have “virtual” services that allow you to practice investing and simulate real life trading situations.  These practice sessions can also help you identify where you feel most comfortable in the investing spectrum.

Your risk tolerance is a very personal matter and can vary because every individual’s situation is different.  Once you have decided on your investment time horizon and your investing personality, you can then choose the type of investments that you want in your portfolio.  Your banker can help guide you in this process or help you find a broker that will perform the same task.  You will want to consider items on the bottom of the risk pyramid first, and then gradually move up the ladder.  For the beginning investor, the use of alternative investments, the higher risk items, should be deferred until later in his or her investing career.    

The “Base” investment vehicles are all forms of debt, mostly referred to as bonds or fixed-income securities.  These are generally short-term instruments with low risk that pay steady income returns.  Government securities may have longer terms, but are regarded as a safer option than high-income corporate bonds.

High-income corporate bonds may offer the potential for higher income payments, but their risk potential and lengthy terms may cause their value to fluctuate.  If market interest rates increase, then bond values can go down to compensate, and vice-versa.  Capital appreciation or depreciation is a real possibility.

Stocks or equities form the next risk group.  The potential for appreciation is the appeal of this choice.  Dividend payments, if any, may be low, in the 2-3% range, but long-term appreciation and more favorable tax rates are the real payoff.  Companies with large capitalizations, the product of their shares outstanding times their average share price, have less risk than smaller issues from medium or small cap firms. 

The rest of the securities can all be labeled “alternative investments”.  They include real estate, options, commodities, foreign currencies, futures and collectibles.  Each category represents a more complicated type of security, along with a more complex investing strategy.  Foreign exchange, or forex, trading has gained dramatic popularity over the past five years due to its flexibility and easy access to trading over the Internet.  However, special training is a must, a forex broker review is necessary to ensure a trusted business partner is chosen, and weeks of practice on free demo accounts are mandatory to achieve success at this trading art. 

Investing for the future is a prudent exercise that everyone should learn about at some time in his or her life.  The process is all about understanding risk, your tolerance of it, and your ability to manage it with a cool head and a disciplined approach to the market.  Follow these common sense guidelines and seek the counsel of a good advisor to help you along the way.

Bi line: Chris Marchalleck is a forex market analyst for forex traders, an online resource for the foreign exchange market and currency trading