4 key understandings before you invest

My car broke down last week. So I phoned my mechanic, Ian, in Green Auto Service who told me to drop it in and he would have a look at it. Now, I have zero interests in cars and how they work, so when Ian started telling me what had gone wrong and what he did to fix it my eyes glazed over and all I was thinking was ‘has he fixed it?’

It can be the same when it comes to investing your money. Most people who come looking for advice on how to invest their money don’t want to know about Alphas or Sortino ratios. They want you guide them on where to put their money without having to understand everything that’s going on under the bonnet.

Unfortunately, it’s not as straightforward as fixing a car, which is a black or white matter. Your car is either working properly or it is broken. Investing is a long term process; in the case of pensions, it may be for decades. There are a huge amount of unknowns that may affect the outcome of your investment. While you do not need to know everything about investments, there are some core issues you need to understand before investing.

How much can it go up?

We invest to make money so it is a good idea to know how much we can make. If we invest in cash, we know we will get a small return. If we invest in stocks and shares, we can get a high return. Then are bonds, property and other types of investments that also give different returns. You can mix them together too and calculate an expected return from the mix.

How much can it go down?

If you want those high returns of stocks and shares, you need to be aware that the potential losses are high too. Taking risk is what gives you the potential for higher returns. There will always be downs as well as ups, that’s how markets and investments work. you need to know what the potential downsides are.

Is this outside my comfort zone?

After having the downsides explained to you, you invested €100,000. One year later, we meet and I tell you the €100,000 you invested is worth €70,000. Do you:

(a) Stay awake all night with worry.

(b) While you’re pissed off that you’ve lost a significant amount of money, you know that it was explained to you that this might happen and that markets come back. There’s no need to panic, you know you will make your money back.

If the answer is (a), you are investing outside your comfort zone and you need to reduce your risk expose.

Remember, it is the fund managers job to assess between good risk and bad risk. When you get that bad news of a big loss, it shouldn’t mean that your money is gone with no chance of recovery…which would be bad risk and your fund manager should be fired.

How does this tie in with my goals?

What are your goals for your money? Most people just want it to grow, which isn’t a goal. If you know your goal, you can work out the returns you need and therefore the risk you need to take to achieve them.

You can then make informed trade offs, take more risk, invest more money or change your goals. Or you may even reduce the level of risk you need to take to achieve your goals.

While you do not need to know exactly how everything works, you do need to know what risk you are exposed to. You can then get on with doing what you would prefer to spend your time on.

If you have any questions, please contact me directly at steven@bluewaterfp.ie

Note: I cannot predict the future, so I do not know what returns funds will produce in the future. We can use past performance as an indicator when explaining risk and potential returns but remember, past performance is not indicative of future performance!!