This is a shortcut that aspiring investors should try to avoid. It can lead to wrong investing decisions with disastrous consequences that you may not have the ability to handle. For example, you could be investing money that would leave you vulnerable to emergencies. Or a sudden downward fluctuation in the market can confuse you as to how to keep your investments intact. Additionally, you could be victimized by investing scams if you didn’t have the proper financial foundation.
With these things in mind, I’d like to outline some pretty basic guidelines that anyone can follow to become a good investor. It’s not rocket science but there’s a good reason for each. And I’d also like to spell out the consequences of not adhering to the idea behind these guidelines.
1. Know the Basics
First of all is to understand money. As investors, our objective is to rule over money and not for money to rule over us. In order to do that, we need to fully grasp the idea of what money is and what it is not.Money is a medium for transactions of goods and services. We earn it and we spend it. We work hard and are paid with money. And we have needs that we buy with the money we earn. In its most basic sense, personal finance is about earning more than what we spend. A person who is able to do this gets to save some amount which he or she can invest.
On a deeper level, investors need to understand that there is a time element to the value of money. One thing to understand is the idea of value behind the amount. An amount of money will have less value in the future than it has now. A hundred pesos will buy far less things ten years from now. This is called inflation.
An investor also needs to appreciate that when you have money now, you have the opportunity to use it and make it grow. That’s why borrowing money has a price which is in the form of interests. The lender is giving up the opportunity of using his own money when the borrower makes a loan. And so he (the lender) demands an appropriate compensation for the benefit that he provides to the borrower.
Another basic but important financial concept that investors need to know is accounting. It’s important because it is a method with which we can assess the financial viability and performance of a business. If an investor doesn’t know accounting basics, he or she wouldn’t be able to assess whether a business is doing good or not. And without this knowledge, an investor will be unable to make investing decisions concerning company stocks. It would be a showstopper for a budding investor to not know accounting.
2. Fix your financial issues
After knowing the basic concepts, it’s time for the aspiring investor to put his financial life in order. Investing cannot be properly executed if the investor is mired in financial troubles. Some of these troubles may include the following:- High Debt
- Out of Control Spending
- Low Income
- Poor Saving Habits
Bad debts incur huge interest payments that can suck the source of capital and the earnings of investments. There are ways to fix it but the bottom line is to get rid of bad debts as soon as possible.
Getting buried in debt is closely associated with uncontrolled spending behavior. But even if you don’t incur too much debt and still lose all your money buying stuff, it’s a problem nonetheless. You won’t be able to save money for investment if all you do is spend everything you earn.
It may be a great idea to “pay yourself first” to solve your spending and saving problems. This only means you take out a portion of your income outright even before you spend a single centavo. This way you will be forced to make do with your budget while your savings is safely guarded.
But if you have a very low income to start with, no amount of defense can help you gain traction with your finances. It would be very hard to save if your pay is just enough for your needs. Realistically speaking, you need extra money that you can put aside on top of what you absolutely require to spend. In order to do this, you need to figure out a way for your income to go up. It may mean asking for a raise, finding a new job, having a business or being a freelancer.
3. Establish a Good Financial Foundation
After you’ve solved most of your financial problems, it’s time to build a solid foundation that your investment will rest upon. This will ensure that your financial health will not easily turn for the worse as you pursue your investments. For me, it comprises of three important ingredients:- Insurance
- Emergency fund
- Budgeting system
Moreover, you would not want your savings to go down the drain when a family member gets sick. Medical expenses can go through the roof depending on the condition. That’s why health insurance policies can become a savior in time when it’s needed. For those who are employed, employers may provide health insurance as a benefit for the employees and their dependents.
Emergency funds worth at least six months of your expenses is also a wise thing to establish. This will help provide for urgent needs for money during emergencies. An investor wouldn’t want to withdraw an investment because he needs cash immediately. This will ruin the investing strategy and may even cause severe losses if the investment portfolio is volatile.
Last but certainly not the least, a budgeting system that works is a must. You need to be able to manage your cash flow effectively. Setting aside the right amount for your current needs, future spending plans, regular savings, etc. won’t be easy if you don’t have a system to make it work. You can easily lose control of how your money is spent without proper budgeting.
I suggest a monthly budget for the whole year should be prepared before the start of each year. This will crystallize in your mind how you will execute not only your investment plans, but also the things you want to do and spend on for the whole year. Budgeting is obviously a key ingredient for the goals that we have set to achieve.
This is the first part of a 3-part series. It aims to set a clear guide for people who want to become good investors. Stay tuned for Part 2 next.
*Photo Credit: El Enigma (Creative Commons)
