here comes a time when every one of us wonders about investing money in the stock market. Whether it’s because of the seasonal hype around the bull markets
that brings some FOMO or a friend that made a huge profit on a particular stock. It can be just our conscious saying - we spend enough, shouldn’t we focus on saving for the future as well? - but everyone has his own mix of reasons for wanting to invest. It can be waiting for the best stocks to invest in or simply wondering how to invest.
By this point, most of us are probably familiar with the notion of stocks and stock exchange. Nevertheless, for those who are fresh to this domain, it's important to mention how to invest or what are stocks. Stocks encompass all the shares of a company that are divided. In addition, hares represent units of equity ownership of a corporation.
Now, people tend to think about the stock market most often when deciding to invest. And for all it’s worth, as long as the market is performing at its best, we will probably get returns on anything. But there is one thing we always know about the stock market and stock exchange, and that is its risky nature.
While it’s not as volatile daily as, for example, investing in cryptocurrencies, stock markets still present us with a serious degree of uncertainty. The rate of volatility gauges the price fluctuation during a specified time frame. The greater the volatility rate, the riskier the currency is perceived to be. However, one piece of advice started to really spread among investors.
The shared wisdom of many successful investors, starting with Warren Buffet, the American business magnate and investor, tells us that diversification of investment classes is crucial for long-term success.
You will hear it often expressed as “not keeping all the eggs in one basket”, but what it means is that we need to manage the money we invest, spreading them in more industries and asset classes that are not related. In this way, we are to a certain degree protected by the bad returns in one industry, having more optimistic yields from another one. As stated by the SEC (Securities and Exchange Commission) - Historically, the returns of the three major asset categories have not moved up and down at the same time. - those being stocks, bonds, and cash equivalents.
But take the market for silver and gold for example. These tend to perform better when the stock market is not. Perhaps it is because they are considered safer asset classes, but you get the point. Having a fair share of such commodities alongside our share of stocks and maybe some bonds can take the risk level of our portfolio down. Now, let’s say you decided to invest in the stock market but don’t know how to approach this diversification strategy.
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A good starting point would be to establish an asset class allocation strategy.
Think about it this way. If you need to provide for your family at a certain point in your life, or you need to take some money out of your investments, having everything in the stock market will make you dependent on the current state of that market. While, for example, an allocation of x% stocks and x% commodities could offer a higher degree of liquidity when needed.
Now, there are different aspects to consider when establishing the percentages of our asset class allocation. Age, risk tolerance, and risk/reward ratio are the most often defining factors for our diversification strategy. The younger a person is, the riskier his asset allocation usually can be. And for a good reason - if you lose a big portion of your money in your 30s, you can still build it up.
However, diversification can take place inside an asset class as well.
And that is what we should do once we start diversifying. The stock market has a fair share of opportunities each day to invest in new companies that will create extraordinary returns for some people, like IPOs (Initial Public Offers) for example. While those are considered higher risk and higher return choices there are also well-established and trusted companies that are trading shares for decades. Remember when Facebook went public? At that time, Mark Zuckerberg liquidated nearly 31 million shares, which amounted to a value of US$1.1 billion.
Even more so, there are index funds that help us choose an average of an industry rather than doing the diversification ourselves. S&P 500 and Nasdaq are great examples of investment choices inside the stock market that have proven a safer profile in the long run.
However, while the idea of diversification is indeed a good strategy to reduce the risk and increase the returns in the long run, it is not advisable to diversify too much. If we can’t manage or don’t have enough funds to make sense of hundreds of different investments, then we should not do it. Even with a portfolio of 10, 20, or 30 investments, we are well diversified, so don’t stress it too much. Always invest as much as you can manage and do it regularly, with comfortable sums. That way, you are buying both the peaks as well as the bottoms, and not investing more than you can afford to lose - and that is a very sustainable strategy for buying the average in the long run.
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