Financial Independence: How do I build wealth and get rich?

14 minutes to read

A happy woman smiles in the background while holding a fan of money in the foreground. Build wealth and get rich.

Can I gain financial independence? How do I build wealth and get rich? These are questions that many people could potentially ask themselves at any stage in their lives. Unfortunately, it is not always possible to find a concrete answer to this that would apply to everyone in most cases. It’s hard to give a straight answer because there is no quick fix, and it isn’t enough to just dream of becoming a millionaire; there is a lot you may need to do to achieve financial independence.

In other words, it’s never too late to start building wealth, nor is it ever too late to start gaining your financial independence. However, we can’t escape the fact that you will have more time and more potential opportunities to build wealth and get rich if you’re from a younger demographic. Regardless of your age, though, the sooner you start to make changes, the sooner you will see results in your life.

Did you know?

The majority of lottery winners will, quite often, return to the same financial level that they were at before they won their jackpot prize.

This is largely to do with the fact that most people don’t have the knowledge that is necessary to keep and grow personal capital.

So, How do I build wealth and get rich?

1. Adapt your mentality

The first step to wealth is to change your way of thinking. If you do not have the right mentality, achieving your financial goals will be made that but m9re difficult for you.

If you find you look for different reasons for someone else’s success, yet you are always trying to find reasons for why you don’t have money, you will have a long way to go until you achieve the levelled mentality that is needed.

One of the biggest resources that any one of us can use to further ourselves in this field is reading books, especially those that focus on self-improvement and write about financial success.

Best Financial Books

These books are fairly inexpensive, no matter which way you look at it and they will tell you about different practices that will help you start working towards financial independence as well as how to achieve the ideal mindset for wealth building.

1 – Rich Dad Poor Dad, by Robert T. Kiyosaki

(Available on Kindle, Audiobook, paperback and MP3 CD)

2 – Think and Grow Rich, Original 1937 Edition, by Napoleon Hill

(Available on Kindle, Audiobook, Hardcover, Paperback and MP3 CD)

3 – The Intelligent Investor, by Benjamin Graham

(Available on Kindle, Audiobook, paperback and MP3 CD)

4 – The Richest Man in Babylon, by George S Clason

(Available on Audiobook and Paperback)

5 – The Total Money Makeover: A Proven Plan for Financial Fitness, by Dave Ramsey and Thomas Nelson

(Available on Kindle, Audiobook, Hardcover and Paperback)

6 – The Psychology of Money, by Morgan Housel, narrated by Chris Hill

(Available on Kindle, Audiobook, Hardcover and Paperback)

By reading these books you can learn many things, like how to get rid of debts, earn a passive income, and even how to better put away the money that you make.

2. Invest in yourself

This point is more of a continuation of our previous point. Investing in yourself requires you to spend time, and some money, on learning and self-improvement.

What does this involve?

Reading
Completing courses
Refining your skills
Building connections

Many people underestimate the importance of getting to know each other and building professional relationships. However, it should be more well-known that people with wealth are almost certainly guaranteed to have important business contacts now that the individual gained by building extremely valuable relationships during the early stages of their mission to build wealth and get rich.

The more skilled and experienced you are, the greater the opportunities you will have.

Your first goal in wealth building should be to strive for a wage raise or find a new job that you want to do and can earn more money in whilst being able to do something that you’re genuinely passionate about doing. Ensuring you are in a job role that you can be proud of and earns you more income will prove to be a solid starting point for you. From this, you can create a more robust financial basis for yourself, bringing your financial independence one step closer.

“The most important investment is to invest as much as possible in yourself.”

– Warren Buffett

3. Save

As we hinted at, at the beginning of the article, there is no such thing as an A-Z guide to getting rich. Still, there are good habits that you could consider that will undoubtedly significantly contribute to your future financial success.

Saving should be considered a main priority if you are looking to build wealth as, without doing it even a little a bit, it is almost impossible to begin to make a more considerable fortune.

You can start saving with small steps:

Spend within your means and never more than what you expect to earn within any relevant time period.

Set a portion of your income aside at the end of each month. If your pay schedule differs from the changeover of the month, do this when the pay cycle refreshes, and you receive your wage. A good level would be around 10% of each wage packet you receive, but only ever save what you can afford to.

Investing the money you save is a wise way to store your savings as, if the market is in your favour, it will be working for you instead of lying stagnant in an account. In addition, some stocks can even earn you dividends, meaning you will receive an extra return as a shareholder from the company at a specified time.

Although, because of market volatility and some unpredictability, f you’re inexperienced here, don’t take on too much and revisit this later in your journey, as at least some market knowledge and a lot of due diligence are necessary.

Properly managing your finances is the first step to financial independence. If you regularly spend on unnecessary things and end up being left with very little at the end of your pay period, you probably wouldn’t be able to keep your wealth growing progressively.

4. Create a budget

Creating a budget to summarise your income and outgoings can be very helpful if you struggle to see where you can start to build wealth.

Keeping track of your expenses and calculating how much you can comfortably spend each month may be more straightforward. You can easily do this with the help of a phone app or even computer programs such as Microsoft Excel.

You may be surprised at how you spend most of your money.

At the beginning of each pay period, determine how much money you will need in different areas of your life (bills, other direct debits, etc.) and set aside an affordable amount of money for savings every month, or pay cycle. This amount will form the basis for the construction of wealth.

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Budgeting in 3 simple steps

Step 1 – Assess your income.

You can’t skip this step, and you must determine precisely how much revenue you have each month.

Step 2 – Determine your expenses.

Create different categories relevant to the different types of spending that you will do in a month, then calculate how much goes towards each category. Classifying outgoings like this will simplify everything to read easily on a page, furthering your ability to determine where you could make changes in your spending.

Step 3 – Calculate the amount you can save.

Suppose you cannot yet pledge a set percentage of your income to savings every pay period. Any money you don’t need to pay mandatory expenses should be put away – still ensure you will have money available to you in an emergency.

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5. Create a plan

If you want to build wealth, you will need a plan and this isn’t just made up of the previously mentioned budget; it will help you a lot to achieve your goal.

With the help of a plan, you can think more specifically about the smaller details and, therefore, more carefully map out the necessary steps you will have to take during your journey.

Your budget and the steps in your plan will undoubtedly adapt and change over time, but if you have a visualised plan, you’ll have a better chance of reaching the goals, further motivating you whilst you work towards the end goal every day.

6. Consolidate any debts

It is important to get rid of all debt as soon as possible if you have any. In addition, if you have previously taken out a personal loan, home loan or other product, it is worth prepaying them as early as you can.

When creating a budget, you also need to consider loans as, until consolidated, they will be an ongoing cost.

If you don’t pay the instalments on time, you will lose even more money due to the rising loan caused by interest. So spend as little as possible and spend as much money as possible to repay the loan.

Debt settlement loan

A debt settlement loan can help you, especially if you need to pay off several loans simultaneously.

With the help of the current debt settlement loans, you can redeem your old high-interest loans and repay the amount at a more favourable interest rate.

We spoke a little more in-depth about the methods that you can use to settle debts, in our article here.

7. Surround yourself with the right people

If you want to be successful, it is important to invest time in quality friends who have goals like you.

It is also necessary to be able to talk to these people about things that will help you move forward, energise you with positive energy and give you strength in difficult times.

If you have friends who encourage you, this can be a great help in difficult moments and difficult decisions.

“Great people talk about ideas, ordinary people talk about things, and small people talk about other people.”

~ Eleanor Roosevelt

8. Invest in shares and real estate

Passive income is one of the best ways to make money. You would find that, if you asked them, almost every wealthy person would likely have investments that make them money, even while they are sleeping.

If your only income is through working, you essentially have to sell your time to make ends meet.

You don’t need a lot to start and could begin investing with very low capital amounts today. If you already have a significant amount of money and just want to build on it, you can even invest in real estate when the market is in a period of stability.

Best investments?

There are many forms of investment, so before making a choice, it would be a good idea to compare the yield and risk levels of different methods before choosing.

Financial Independence

9. Start your own business

Setting up a business of your own can sometimes be highly profitable. Although success here relies on several factors that you will need to consider – for example, are you offering people a valuable and useful product or service?

It is not easy to create a successful business, but if you are willing to put in enough time and work and can cover any initial investments you may need to make, you can certainly earn a great income level over time. It is a sure thing that hard work will bear fruit here.

Don’t put all of your eggs in one basket

In the beginning stages of building your business up, if possible, only work for it in your spare time and definitely only leave your current job if your company reaches a stage where it can easily provide you with a secure livelihood.

10. Take risks

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It is important to preface this point by saying always pay due diligence and be sure to always stay within your financial means.

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Don’t be too afraid to take risks. If you always air on the side of caution, at least too much anyway, you will find it is a difficult way to build wealth and get rich.

Those who live too comfortably and find it difficult to do anything outside of their comfort zone will not try new things, even those that have the potential to put them in a better position.

People who know how to build wealth and get rich will dare to take risks, try new things, and learn from the mistakes they have made.

Do you want to invest, but have you always been afraid to make the wrong decision? The internet is full of free courses to help you get started on the path of investing. It is important to not feel like spending on paid learning materials is a bad thing or like it will set you back; it won’t: these resources often contain information that will serve a much higher value for you in the future.

11. Think about variety

Even though risks can prove to be a good move and have a good payoff, it’s not the best decision to just focus on only one area.

Although over-diversification can be a bad thing, don’t just strive to be good at one thing, try to improve in as many ways as possible.

If you focus on just one thing and ignore everything else, you can potentially lose out on a lot of useful information and opportunities. This could cause a lot of harm to you and your potential finances in the long run.

For example, say you did set up a business – you invested all of your money into it and it became very successful. What if, after a while, your circumstances change and you no longer have time to serve the business but don’t want to employ staff? this could cause you to have to give the business up and you would financially have to start building all over again.

However, if you have gotten to a stage in your mission to build wealth that means you can confidently accept any potential losses, investing some of your money in real estate, stocks and shares, means that your risk exposure would be divided. This means that the successes you have would compensate for any loss you may experience in another area of your portfolio.

Our article here looks deeper into the subject of Diversification. It talks about topics such as why it is a good practice and the different types of available investment products. Also, it discusses the subject of over-diversification and the adverse effects this has on a portfolio.

Create more sources of income and always have an asset that will passively generate money for you – this should be the main goal as a successful passive income will take you leaps ahead.

Find new opportunities and try out more new things to try and further yourself. This increases your chances to get rich and build wealth successfully.

12. Don’t procrastinate

If you postpone everything, you will never achieve your goals or find it more difficult than you should. We understand it is easy to think you have plenty of time left or you will do a particular task “tomorrow”.

This way of thinking can be seen a lot in younger individuals. You think you will have plenty of time to achieve your goals.

Unfortunately, this mindset will help you to get nowhere fast. You may realise in 10 years that if you had taken that first step today, you would have been miles ahead from where you ended up and much closer to where you want to be at that stage.

Conclusion

In summary, wealth can only be achieved through developing useful habits and attributing yourself to proper, invested work. Try to spend less from month to month and, once you would able to financially recover from any potential loss without too much difficulty, invest a large amount of your savings to increase your money’s value.

If you know your financial goals already, in order to have more money later, it is always best to take the first steps today rather than waiting and putting it off until later.

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High Inflation! How should we invest if inflation remains high?

3 minutes to read

How should we invest if inflation remains high?

Those who expect persistently high inflation should think about inflation-tracking retail government securities centred around the US Dollar and the Euro. But, on the other hand, with the right timing, commodity investment funds and stocks also have the potential to perform well.

Inflation is likely to be only temporarily close to 6-7% in the US. From the second half of 2022, the consumer price index may gradually return to close to 2-3 percent, based on expectations.

If it is predicted that there will be higher inflation on more of a permanent basis, you may want to choose the following forms of savings.

Raw materials

If we turn to the universe of risky investments, commodity investment funds can perform well in a high inflation environment.

In the post-coronavirus period, many governments around the world are invigorating with improved infrastructure measures. Meanwhile, the supply side faces a capacity shortage and supply chains are faltering. After the closures, a significant demand hit the construction industry worldwide, but trade and geopolitical tensions also pushed up the price of raw materials.

Moreover, the supply chain is relatively inflexible. For example, it takes a good two years to create a modern sawmill, while opening a new mine may take up to a decade.

Through their bond-buying and liquidity-enhancing programs, central banks have injected huge sums into the banking system and economy on the demand side of things. This money is present as a demand, raising the price of commodities. This links to the increasing number of wage increases.

This environment has led to significant price increases in the raw material markets.

After the prices of many raw materials have doubled in recent times, the question is whether or not it’s worth entering trades or investments after such a significant increase and buying, for example, a commodity fund.

Suppose China could avoid a slump in its real estate market and a significant slowdown in its economy. In that case, commodity price increases may continue for some time to come, although the pace is likely to moderate. The significant price increases may be behind us.

Domestic, German and U.S. stock markets are at historic highs. Stocks have traditionally performed well in higher inflation environments. If inflation is too high, it can be harmful. In this case, central banks will have to make significant cuts.

Higher inflation is particularly concerning for the U.S. Federal Reserve (FED).

In the United States, the rate of economic deterioration rose to a 13-year high of 5.4 percent. One-year inflation expectations jumped to 5 percent, and 3-year inflation expectations, which better capture longer trends, jumped to 4 percent overseas.

As a result, the FED could phase out its bond-buying program entirely by the middle of the year and even begin a cycle of rate hikes. However, this can trigger a negative correction in equity markets.

In light of this, it is advisable to buy shares in the form of several positions (known as dollar-cost-averaging), with more of a long-term view. This technique can reduce the risk at the time of purchase.

If a 10-15% correction were to develop in the equity markets, it could be another possible point of entry.

In this case, the extreme optimism in the markets could be tempered, investors’ cash holdings could recharge, while the pricing of equity markets would also return from the current very high levels.

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Are Small Investments Useful?

11 minutes to read

Small Investments

We often find ourselves giving in to the common misconception that only more significant investments are where the main capital gains are achievable. Yet, against popular belief, even smaller savings are capable of profit-making, and even small investments can become profitable, especially if you do them regularly.

Many people think that there isn’t much to be done with the last bit of spare money leftover from their previous wage each month because, from some people’s perspective, this leftover amount doesn’t really equate to much value. However, considering that regular monthly investment can usually result in quite a nice return, the previously mentioned misconception is not a good outlook to adopt as that leftover money can most definitely go a long way, no matter how small.

As we had mentioned in our in-depth investing guide for beginners, it is now possible to invest with as little as $10 on the eToro platform.

To do this effectively, of course, you need to know which products are worth buying in small quantities on the market. Although, unfortunately, if you want to invest a small amount, you may not have as many opportunities as others.

Investing in eToro

eToro is one of the most popular and chosen online brokers. If you were to read the reviews about the company and get to know the services on the site, before long, you would soon come to realise how good of a platform it really can be!
Find out more about eToro: Here

When should I choose a small investment?

You should at least consider a small investment, if:

You have little savings, and you want to increase them.
You’re a beginner and don’t know the market very well.
You want to begin generating long-term returns
You want to try a new product
You don’t want the risk exposure associated with larger amounts of capital.

Benefits of small investment

You’re only risking a smaller amount of capital.
It helps give an understanding of how the market works.
It is easy to diversify with smaller holdings.
You can choose from flexible products.
With regular investment, your portfolio can achieve good returns.
There are leveraged products available.

Disadvantages of small investment

Patience is needed when it comes to developing the desired level of holdings.
Fewer options are available.
The risk is the same.
In the short term, potential yield production may be limited.

Minimum capital: $10 to $10,000

Possible profit: very high

Time horizon: 5+ years

Competence: very high

Risk: very high

Stocks are potentially one of the most popular investments. Thanks to the variety of shares, everyone has the ability to find a product that is perfectly suited to them and their portfolio types. In addition, since we are talking about an investment type that has high diversity potential, you can often find shares that can quite oftenly turn out to be a profitable choice even with very little capital.

Despite the previous point, nobody can forget that stocks are relatively risky. If you want to invest a small amount, it certainly means that you don’t have much savings. With this in mind, you should be especially careful when it comes to stocks because, with a wrong decision, the investor can easily lose even that small amount.

If you want to buy shares, we recommend that you think long-term and preferably not rely on the shares of just one company. When you spread your investments, you are in turn exercising risk management which will actually protect your capital investment should something happen to that one particular company that you would have originally placed all of your money in. This, in essence, means you won’t lose everything in one go.

Bank deposits

Minimum capital: $1,000 to $10,000

Possible profit: low

Time horizon: 0-1 year

Savvy: low

Risk: low

A bank deposit is generally a safe investment, so it’s recommended especially for those who do not want to put too much risk exposure on their money.

Some may not realise this, but you will be required to have a bank account to deposit. The amount paid will be the bank’s property for a while, but, in return, you will receive interest from it. At the end of the term, you will receive the amount and the interest paid on it.

It is worth noting that, in the case of a bank deposit, we haven’t addressed and talked about is the sometimes high-interest rates. So, for example, you can get a higher return on a share, but you can choose a bank deposit if you want to be sure of reduced risk.

Also, remember that because you have protection when it comes to the deposited amount, you wouldn’t lose your money even in the event of bankruptcy.

Gold

Minimum capital: $1,000 to $10,000

Possible profit: low

Time horizon: 1-5 years

Savvy: low

Risk: low

Gold is an available investment option that has been present in the market for a very long time. It is the most popular investment among precious metals, and most of the time, investors will buy gold for diversification.

Another reason for gold’s popularity is that it can retain its value better than most other securities. An excellent example of this is that shares will decrease in value more than gold in the event of a crisis. Moreover, the value of gold will likely increase during a crisis; this is because many people will invest a portion of their money in gold as a portfolio safety net.

The value of gold is on the rise in the long run. Since we are talking about a rare and finite amount of precious metals, you can be sure that gold will retain it’s value in the future.

If you’re looking for a small amount of investment, gold can be a great way to counter inflation.

Bitcoin

Minimum capital: $1,000 to $10,000

Possible profit: very high

Time horizon: 1+ months

Competence: very high

Risk: very high

Bitcoin could easily be the most popular and well-known cryptocurrency. Cryptocurrencies are internet currencies that operate without a bank or other centralised body. Instead, blockchain technology allows transactions to take place exclusively between users.

Originally Bitcoin was created to keep people safe and allow them to store their money independently of any bank. In our current society, websites and big-name businesses are increasingly supportive of Bitcoin payments, although the future of cryptocurrencies remains in question.

For sure, Bitcoin is currently a very trendy product, and most people see it as an investment. However, the price can be very unstable, which is caused by market volatility, and this is why you can quickly lose your money.

Bitcoin is better recommended to more experienced investors, but – on the other hand – you don’t necessarily have much to lose if you only want to invest in small amounts and can then gain valuable market experience and knowledge at the same time. The yield on leveraged products is likely the best to use to compare to Bitcoin’s yield.

P2P loans

Minimum capital: $1,000 to $10,000

Possible profit: high

Time horizon: 1-5 years

Savvy: low

Risk: very high

Peer-to-peer loans can be a good source of income for the lender. If you want to invest, you can give credit to people who need it.

Since there is a demand for such loans, smaller amounts are utilised equally to more significant amounts. This point is important because banks usually don’t deal with options such as these less significant amounts. Moreover, when it comes to P2P loans, the borrower will pay interest on the money lent, so, like a bank deposit, you will earn a guaranteed return.

The borrower will also benefit, as they have access to a loan with a lower interest rate than they would be able to source from any bank.

Such lending isrelatively easy to source on most platforms. These sites can easily connect you with the borrowers that suit you.

! Attention !

The use of P2P platforms is prohibited in some regions. Therefore we urge you to DYOR and source the correct information relevant to your specific country orregion. Only if you find that it is not unlawful to do so, should take full advantage of P2P lending.

Commodities

Minimum capital: $1,000 to $10,000

Possible profit: very high

Time horizon: 5-10 years

Competence: very high

Risk: very high

As a term, “Commodity Products” is used to describe raw materials and basic products that are suitable for investment.

These products include:

Agricultural products
Commodities
Metal goods
Livestock goods

There are several ways that you can invest in these products. The, seemingly, obvious solution for some would be to buy and store physical product. Although, because of the sheer required storage space alone, this is far from a favourable or recommended method. Instead of this, in the majority of cases, it is more highly recommended over anything else that investors buy into an ETF (Exchange Traded Fund) that is suited to their portfolio requirements.

Buying ETFs is much more straightforward and a much more obvious choice in the way that investors can implement them on almost any platform. If you are looking for another alternative, you can choose a suitable investment fund instead.

It is important to remember that when buying a product, you need to be thinking with a long-term mindset.

Invest in Yourself

Many people forget that self-improvement is one of the most important things in the world that you can turn your attention to. Often, learning a new skill holds a lot more value than any product you can find on the stock market. If you spend money on improving yourself, you will almost certainly be making the best decision possible.

If you aim to make more money, the easiest way to go about this is to further develop the skills that will better assist you in achieving these goals.

For example, if you want to invest in the stock market, you you may enrol into a course that will advance your knowledge in new investment methods.

Also, it is advisable that you ensure that you give yourself the opportunity to gain enough personal experience traversing the market, as well as market knowledge, to the point that you feel more comfortable and certainly confident in it processes. An example of a platform that accommodates this necessary stage in any investor’s journey, is eToro, it is one of the most popular investment exchange platforms and provides all newly registered users with demo accounts so that they can do just this and gain necessary knowledge and experience before needing to have true risk management skills.

With the amount on the demo account, you can invest without risk, therefore you can experience not only how to properly use the site, and its different features but also to see how the various different products behave.

How do I create an account on eToro? Guide to open an eToro Account

CopyTrading

For many people choose eToro because of its CopyTrading service. CopyTrading allows you to replicate the movements of more experienced investors. Commonly, individuals usually feel safer in their market movements when they have received this kind of assistance from an experienced party.

If you decide to choose CopyTrading, first compare different investors based on their eToro profile. On the site, you will find all the useful information about them that you will need to make a decision, including the recent profit/loss they have made on their portfolio.

Don’t forget the risk!

CopyTrading may be a good decision, but the risk is there with every investment. The functioning of the market cannot always be determined in advance and therefore experienced investors can also occasionally lose money too.

Pay attention to this when investing a small amount

It is worth taking a few tips of advice when it comes to small investments. This includes the following:

Don’t have unrealistic expectations. Since small investments are usually long-term, you will only generate true returns over time.
Don’t forget about the risk. There is also risk involved when you invest a small amount of capital. If you choose the wrong product, you may lose the entire amount of money.
Try to invest and diversify regularly. The more products you invest in, the safer your money will be due to portfolio diversification.

Synopsis

If you are a novice investor, starting by investing with smaller amounts is a wise decision. The market has many possibilities for you to choose from, all you have to do is be sure that the product(s) that you select suits you and your planned portfolio requirements as best as it can.

Remember, small investments also have pitfalls, so if you choose a risky product, it may be worth seeking an expert’s opinion. It is also always important to only risk as much money as you can afford to lose without being overly affected.

Disclaimer:

You make every investment at your own risk. Your money is at risk, and past performance may not be a reliable indicator of future results. You never know if an investment will pay off or not.

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IS THERE A LINK BETWEEN DUMB MONEY AND THE FUTURE PROFIT OF THE EQUITY MARKET? (Household Equity shares)

7 minutes to read

THE LINK BETWEEN DUMB MONEY AND THE FUTURE PROFIT OF THE EQUITY MARKET

Often referred to as silly money, dumb money is in reference to the average investor managing the investment steps of their own portfolio’s capital. A well-known platitude of the stock market is your average investor buying high and selling low. It is because of this trend that, at the peak of the stock market rise, the average investor portfolio holds a high number of shares. The question here would be;

“is there a link between dumb money and the future profit of the equity market?”

In this article, we will discuss how to track a portfolio’s level of equity exposure, as well as studies that have examined the reliability of this correlation trend. Household equity shares.

The topics covered in this article are:

What does dumb money do in the stock market?
Why is household equity exposure important?
The relationship between household equity exposure and future returns

What does dumb money do in the stock market?

Dumb money indicators are often referred to as ‘mom & pop’ indicators, referencing the fact that the average investor invests their money generally uninformed, are less skilled, and are generally more likely to make more irrational decisions. It is only named this because, if we have enough skill to know how to read and apply the indicators that are most relevant to our portfolio, we can more easily – and more accurately – make market predictions for the future. Practically, it is based on this principle of households, housewives, methods of following silly money. To follow the steps of housewives, you can use several different indicators.

The most well-known of these indicators are:

Dumb Money Stock Confidence Index
Equity / Money Market Asset Ratio
Retail Money Market Ratio
NYSE Available Cash Interpretation
AIM indicator
Rydex Ratio
AAII Investor Sentiment Index
Households equity exposure

From those shown in this list, the AAII may be a popular topic but it doesn’t get all of the airtime. Another prevalent indicator from this list would be Household Equity Exposure, which we discuss in the following section of this article.

What makes household equity exposure important?

In recent years, there have been regular reports in the economic media (You can see those reports here, here and here) that U.S. households hold a record ratio of shares. When we say record ratio we mean that these households collectively hold at least 40 per cent of relative investment vehicle shares.

In the image below, we can – in a slightly more credible/comprehensive way than the articles quoted above – track the ratio of the value of shares held by U.S. households to all investment vehicles. Furthermore, according to this, 40% of US household assets are currently in equities. News has shown us the index had a higher value even before previous economic crises, an extraordinary situation that hasn’t been witnessed since Second World War.

Household equity shares — households stocks graph

Anyone who has noticed that, even before major crises (see 2008 crisis, 2001 dotcom bubble), the value of the indicator peaked (see red arrows), it committed a bias in retrospectives.

In hindsight, it’s easy to mark the tops because we can have a good understanding of where they may lie in the future. However, if we couldn’t loosely predict the future, we wouldn’t be so confident since, for example, in the three years before the dotcom bubble, household equity exposure was at a historic high (above 30%), and the collapse didn’t happen for another 3 years. Therefore, it is possible to show with significantly more accurate statistical studies than visual inspection whether there is any link between the equity exposure of households and the future returns of stock exchanges.

Let’s look at the details of this further.

The relationship between household equity exposure and future market returns

The research, published under the title The Household Equity Share and Expected Market Returns, specifically looked at whether there was any correlation between household equity exposure and future return on the stock market spanning the period of 1953 to 2015.

To carry out the study, the household equity share (HEShare) indicator was created, which shows how household equity exposure changes over a given period of time compared to money market instruments. According to this, Household Equity shares varies from 0 to 1, where for value 0, 0% of household wealth is in shares and 100% in financial assets.

At the other extreme (A Household Equity shares value of 1), household equity is entirely in shares and no financial assets are held. Of course, as we have learnt that the fluctuation of equity exposure lies between 55-80%, we cannot show these extreme values in reality.

When looking at the history of the Household Equity shares indicator, particularly over the period of 1950-2015, we can easily gain great insight. Immediately we can observe that this indicator fluctuated between 55-80%. Meanwhile the corresponding chart of the FED (Federal Reserve) only shows a fluctuation of 10-40%. The reason for the difference is that the Household Equity shares indicator looks at the ratio of shares, strictly that of financial assets, and the FED’s chart shows the ratio of shares to all investment vehicles.

How to follow the Household Equity shares indicator?

There are multiple factors that are attributed to this indicator, which make it such a great tool for all.

Let’s take a look at the main elements of the indicator in the section below.

Household Equity Shares Interpretation

Household Equity shares represents all shares held by households, which is the sum of shares directly owned by households and shares purchased through investment funds. The exact data can be found in the FRED (Federal Reserve Economic Data) database and in the federalreserve.gov database:

Direct shares, under the name FL153064105.Q
The value of shares purchased through investment funds under the name FL153064245.Q.

Household Credit Assets Interpretation

Household Credit Assets represent the financial assets of households, which is the sum of three data sources:

Article FL154022005 Q – mortgage bonds
FL154023005. Q – bank deposits
FL153064235. Q – bonds

The above data can be obtained from the FRED and federalreserve.gov database.

In summary, the research discussed did in fact find a correlation between household equity exposure and future returns on the stock market. According to this, if household equity exposure increases, then the 5-year future return on the stock market can be expected to be lower.

It is important to see that this indicator does not have the capacity to time the market in the short term, it’s task is to predict the future yield of 5 years. But don’t forget, even though it predicts with a high reliability at this level, it is not infallible and can potentially be incorrect. There wasn’t always a close relationship between Household Equity shares and the yield for the next 5 years, this was particularly true in the 1980s.

Further to this, the correlation of Household Equity shares also in fact coincides with other correlations as well.

Of these, the correlation coefficient with, quite popular, CAPE is 0.4, which assumes a medium linear relationship (explanation of the correlation coefficient here). In fact, this means that in addition to CAPE, the role of the Household Equity shares indicator can also be a strengthening one.

Learn more about investing

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All About Mutual Funds

12 minutes to read

A Mutual fund is a simple investment method, an excellent choice for novice investors.

People who want to invest have probably heard of investment funds. These products may seem favourable and convincing to novice investors.

As we have previously told you in our article specifically written on diversification, when investing diversification from different products is important because it can reduce risk and increase your portfolio’s security against major losses.

An investment fund is a perfect choice for this, as it allows you to put invested money in several places with less time expenditure..

The concept and operation of a Mutual fund

An investment fund should be considered a coffer** within which anyone can deposit their money. Contributors own the coffers in different proportions, depending on their level of input and will receive their profits on this basis also.

Just like with shares, the more value you invest the more ownership you will build.

All an investor has to do is carry out the initial depositing of their capital into the coffer: the collective amount is then managed by appointed experts.

Why is this a good thing?

The fund manager can invest in several products that they believe to be profitable, which means you can gain a higher level of diversification from this one product, yet you don’t have to do anything to contribute it to your portfolio.

These products can be very diverse: what matters most is what provides the highest returns in the current market. Also included are a wide range of securities, real estate, bank deposits and shares.

The creation of an investment fund is the responsibility of the fund manager, which means they are also soley responsible for management of that fund.

** Coffer:

a strongbox or small chest for holding valuables.
the funds or financial reserves of an organization.

Investment Fund or CopyTrading?

If you don’t want to invest in an investment fund online, CopyTrading would be the next best alternative.

The CopyTrading feature, which can be found on eToro, is similar to how an investment fund works:

You can elect to mirror the investment habits of your investors that you have chosen yourself. Here your money will essentially be invested in products for you by the selected investor(s) as you would be following their decisions.

As CopyTrading is an entirely free service, which proves to be a convenient, and very helpful, investment tool for novice investors who may have less market experience or knowledge than most.

Find out more about eToro CopyTrading

Types of investment funds

Grouping of investment funds

Investment funds are more often grouped according to the type of products they include in their indexes. On this basis, we can talk about the following types:

Money market investment fund: this type invests in money market funds, government securities and various bank deposits.
Bond funds: different bonds are bought under this kind of fund.
Equity funds: here shares offered by different companies are the focus.
Mixed funds: within in this portfolio, you will find a combination of both stocks and bonds.
Real estate investment funds: this type of fund will invest in properties that have already been built, or are currently under construction.

Special investment funds

Absolute return funds: they do not have a specific investment area, as the fund manager selects this depending on the market’s current performance.
Capital-protected funds: the invested capital is paid back as a guarantee after maturity.
Derivatives: invest in securities through derivative products.

Types of investment fund

There are two distinguished investment fund types:

An open-ended investment fund is available to anyone. Anyone with enough capital can purchase units.
Private investment funds: Only those who meet certain requirements can access a fund of this kind. As the fund manager is responsible for them, these conditions can vary between the different funds.

There are also closed-end investment funds, which operate with maturity. You can only redeem the invested money after the maturity has expired, which will result in the termination of the investment fund.

On the other hand, an open-ended fund can be redeemed at any time. In addition, there is also an open-ended fund that allows you to buy an investment ticket continuously.

Investment fund maturity

The fund’s duration varies, starting from a few months, spanning all the way up to 3 years.

Funds with the shortest maturity are called liquidation funds and they invest in bonds with maturity equalling less than three months.

When it comes to investing in, the previously mentioned, closed-end funds you must be sure that you are comfortable with not being able to sell the fund asset until the end of the maturity term.

Are investment funds safe?

The risk level of an investment fund is shared with your own sole investment of a specific, self-chosen product. It is widely known that there is always a risk, with any investment portfolio. As stated in our article focused solely on diversification, you can significantly reduce a portfolio’s level of risk by investing in several products at once.

Read that article here

If you choose an investment fund, you will get so many benefits and you won’t have to invest anything yourself. A fund manager is an expert whose aim is also to make a profitable ROI.

A good choice for beginner investors

If you don’t have a lot of market knowledge or experience – or maybe you just don’t have the time to research the ins and outs of particular products – then an investment fund would be a suitable choice for you.

Although there is no form of reimbursement given when an investment fund makes losses, you would in fact receive a refund in the event that the investment service provider finds themselves unable to pay you. For example, this could happen if the provider was to be declared bankrupt and becomes insolvent.

As we have said, the risk is present here in the same way as in other investments, and the extent depends on the chosen products. Including this there are both pros and cons to utilising this kind of product, such as the following found below:

Benefits

Everyone will find the right type and security for them.
You don’t have to invest a large amount of money to have ownership in a ‘coffer’.
The overall concept can be understood by relatively anyone due to its simplicity.
They are much more profitable than holding your money in a bank account.
You can always get out of the investment.
You won’t need to sacrifice time and energy researching your own products individually.

Disadvantages

You cannot accurately determine the amount of return that will be due.
The level of profit has many variable factors which can affect it.
Those who understand the market can individually choose more profitable investments.
You don’t decide where your money will be invested. (This, for some, can be worrying and cause stress)

Investing in an investment fund

To invest in an investment fund, you must have a securities account. You can open such an account with almost all banks and brokerage firms, so this shouldn’t create any problems.

If you have the account, you are essentially ready to invest. Remember that a securities account also has costs.

By buying an open-ended investment fund, it will be easy to get out of the investment. At the current value of the investment, you can sell the product, but you have to take into account that you will not get the full price.

Typically, you will lose 5-10% because most funds can only be sold at a lower value. This is also true for closed-end funds.

The security of your money

When investing, it’s always important to keep your money safe. Therefore, the amounts invested through investment funds can be protected by a number of different Investor Protection Funds, the one that is responsible for protecting your invested money is entirely dependent on country. Here a few examples of the different authorities:

The FCA is the first example we will use. This stands for ‘the Financial Conduct Authority’ and this one in particular serves the UK

The next example would be CIPF, which stands for the Canadian Investor Protection Fund.

Finally, the overarcing organisation that covers the US is the SEC, standing for ‘The Securities and Exchange Commission’. This is the number one regulatory body in America.

Investment fund costs

When investing, you also need to consider any costs. It matters what conditions you start your portfolio; this is because your portfolio’s overall yield is greatly influenced by the costs you incur along the way.

Simply put, if you have to spend half of it on expenses, the money you make would be much less. An investment fund is no exception to this and so it is worth considering the costs of the given product before making a decision.

Most costs are indicated as a percentage. The 1-2% figures may seem small, but a 2% fund manager fee could potentially mean millions in the long run. The more money you invest, the higher your costs.

In the case of an investment fund, the following fees may be incurred:

Fund manager’s fee: This is deducted from the total assets each year, and typically stands between 1-3%.
Supervisory fee: Mandatory fee, which is usually 0.1%.
Custody fee: A fee paid to the depositary ranging from 0.05% to 0.3%.
Success fee: Most funds pay a fee when you make a profit. This can reach up to 20% of the yield. This is the largest of the fees you will come across, pay special attention to what percentage this stands at before starting any investment.

Annual costs

In addition to the listed fees, other costs may occur. The rate of these range from 0 to 1%.

It is important to note that regardless of whether a profit is made from the investment or not,

costs must be paid every year.

The success fee is the only exception, in that it is charged only in the case of a positive return.

Selection of the investment fund

Since there are so many choices, at first it can be difficult to know which product is best for you. There are three things that can help you make your decision.

Maturity affects yield

There are investment funds that are only worth withdrawing for a long term. Short-term funds usually mean little profit, so expect to be without money for up to 4-5 years before investing.

The risk should not be forgotten about

Without risk there would be no profit, this is because the two are directly proportional to each other. The higher the risk, the higher the return you can expect. For novice investors, it is recommended to choose low-risk investments when first starting out.

Keep your goal in mind

If your aim is to use your invested capital in the near future, it would be more worth it for you to invest a low-risk stake.

If you don’t have a specific investing strategy and you just want to make money, as an advantage you could try trading in higher-yielding products.

Why invest in an investment fund?

There are a number of positive reasons as to why investment funds are worth looking into, some of these are:

Easy to buy. Mutual funds are available to anyone, and no investor experience is necessarily required to buy them.
Cost-effective. Investment funds usually have low costs.
The risk is managed effectively. Mutual funds invest in many products at once, so they are typically not as risky as self-investing.
A flexible investment. Investment funds can be purchased and sold at any time, so there is no need to adjust to a predetermined maturity.
Expert help. Your money is invested by experienced professionals who know a lot more about how the market works, when compared to that of novice investors.

Other investment opportunities;

There are many other investments on the market that may be better suited to your needs. Before you make any final decisions, compare any considered investments based on profitability, risk, maturity and the relevance each one has to your own goals/aims.

Frequently asked questions

Who can invest in investment funds?

Anyone can invest in open-ended investment funds. You just need to have enough spare capital to buy into an investment fund.

Where can I buy an investment fund?

You can also invest in investment funds through banks and brokerage firms. If you invest through a bank, you will need a securities account.

How risky is an investment fund?

The risk of investment funds depends on the products chosen. Your money will be invested by experienced investors in products that they have determined will become profitable.

Every investment fund has a level of risk. If you want a lower risk, you need to choose the right basis for it.

What is the minimum recommended investment period?

During the minimum recommended investment horizon of the investment fund, exchange rate fluctuations are balanced. If you invest for a smaller horizon, you can reduce the level of risk the fund will expose you to.

Who invests the money paid into the fund?

The fund’s coffers are managed by experienced, expert investors. Their goal is also to invest the money raised into profitable sources.

Synopsis

An investment fund is a diverse investment option, so it is recommended for novice investors to utilise this type of product – this is also recommended partly due to the level of risk management that goes into it.

Those who are looking for a higher return at higher risk would also be able to find the right product for them.

Lastly, from this article, we know that more experienced investors are able to find more profitable options due to their market knowledge and experience, allowing them to know more certainly which product is a good prospect and which is not

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How Investment Diversification Reduces Financial Risk

10 minutes to read

Diversification is fundamental for sound investment portfolios. Yet, despite the importance of investment diversification, its meaning remains vague for many. When wealth building, it is important to strive to reduce the level of risk in your portfolio.

This article aims to aid your learning of how to begin minimising risk while your savings increase. Let’s get started!

What is diversification?

The essence of diversification is the reduction of losses by spreading the risk burden.

Let’s say you collect an amount of physical capital, and you now want to invest that money.

How do you go about investment diversification?

You read an article online that says how particularly well a technology company is doing at this moment in time. After reading the article, you decide to invest all of your money in shares of that single company. Then, when they release the quarterly report, it shows they never reached their projections, and the exchange rate starts falling sharply. Now roughly 40% of your invested capital is already absorbed, and you face losing everything, should the share price continue to plummet.

An alternative situation to the scenario mentioned above would be that you seek out some level of professional advisory.

Nine out of 10 experts are likely to recommend buying a bigger multiple of, preferably, different products instead of just several smaller ones that are all similar to eachother.

To create such a portfolio, for example, you would buy a smaller real estate unit, as well as government securities, bonds and shares. It would even be possible to further add more investment assets different to these ones. By building your portfolio like this, you would be able to spread the risk, therefore reducing how much is held in each asset. And if the value of one asset decreases (Like with the stock price we used as an example previously), then only a smaller portion of your entire wealth is lost, because only a small percentage loses its value. This is what diversification is.

You can read about the basics of investing here

Why is diversified investment important?

As we have said, the aim of diversification reducing the risk of investment. As long as you keep your total capital in only one investment vehicle, there is a chance that you will suffer a significant loss as a result of an unfortunate event.

Economic processes are constantly changing and, therefore, so is the value of all the different assets. As a result, crises come and go – during which the value of various investment vehicles can fall significantly.

But on top of that, many things can affect their value. For example, a high-value property is still just a building and can become badly damaged (House fire) or even the quality of the property’s surrounding area, both of these reasons, and many more, can cause the property value to depreciate. Your money invested in the shares of an IT company could easily fall because of the scandal surrounding the company. And, further from this, your bonds can be devalued more or less overnight. Moreover, unfortunately, there have been cases in recent years when the issuing financial institution has become insolvent (not able to repay owed debts – bankrupt).

Although these examples seem to be extreme, over the last few years such stories could be read in credible news outlets. Unfortunately there will be more cases of this nature heppening in the likely not-too-distant future. Therefore it’s better not too underestimate the chance of such situations occurring.

In the case of a varied portfolio, usually only a small part of your assets will be in threat at any given time This makes having a diversified portfolio is moderately risk-reducing.

How does diversification work?

The most important rule of diversification is to invest in assets whose exchange rate movements don’t correlate. That is, the fall in the exchange rate of one asset class does not cause a negative change in the other.

Let’s say, hypothetically, you put 40% of your savings into an investment fund with high-risk technology stocks, and 60% into a low-risk sovereign debt or bond mutual fund. Thus, fluctuations in the price of high-risk stocks will not have such an impact on your overall savings.

By putting your money into mutual funds, you are diversifying on your own, because you are not putting everything on one company, but on, say, 60-70. So of course, here it is also worth carefully exploring the characteristics of the investment vehicle.

What should you pay attention to when building a diversified portfolio?

When developing a diversification strategy, think primarily about:

What are individual goals?
Do you want to invest regularly or in one lump sum?
How much return do you expect?
How long do you want to invest?
How much risk are you willing to take?

Do you need a flexible, disbursable**, easy-to-monetize (liquid) form of investment from which you can quickly withdraw your money if necessary? Or do you have more of a long-term reserve that you won’t expect to touch for years?

Each investment vehicle has its own characteristics. The goal is not to have money everywhere, but to divide it into a percentage of different options, thus reducing the risk.

**able to be distributed or scattered – definition source here

Why is diversifying important?

In the world of investments, there is a rule of thumb: the risk taken is proportional to the level of return. So, on the other hand, a low-risk government bond will also give a low yield. But, due to the low risk of the government bond, the returns are more or less guaranteed. Exceptions to this would include; the bankruptcy of invested companies, war and economical collapse(recession).

A newly listed company with high expectations from investors promises high returns. However, bad political or economic news can be enough to cause a stock’s value to fall by 20-30%.

This shows that it is worth diversifying our investments primarily on the basis of risk levels. On a scale ranging from low-risk investments to extremely risky assets, you need to choose the forms you’d like to invest in. Of course, it is worth combining the different risk assets in certain proportions that are relevant to your overall strategy.

What major asset classes can you invest in?

Government securities

Government securities are one of the simplest, least risky forms of investment. When you buy government securities, you essentially “lend” your money to the state, that is, you get a state guarantee. Low risk is accompanied by low returns.

Bonds

A bond differs from government securities in that you don’t “lend” your assets to the state here. Instead, they’re “loaned” to a financial institution or company, and for a fixed period of time. The risk is higher here too since, in this case, it is more possible for a company or financial institution to become insolvent(unable to pay arrears in any case). In addition, the so-called exchange rate risk is to be taken into account, which is due to the change in the value of the given bond. The higher the yield on a bond, the riskier it is.

When you buy shares, you acquire a small slice of the ownership of a particular company. This investment vehicle is an extremely high-risk asset, which should only be considered if you have good market research, market experience or – if you are more inexperienced than most – are prepared to potentially experience losses within some of your trades.

Read about market risk here

Property

A real estate investment is one of the so-called illiquid investments. This means that it is difficult to exchange a property for cash. Buying and selling a property, or even renting it, takes longer, so if you need money quickly at any time, real estate is not the best way to invest your property. In the case of long-term financial plans, however, this is an excellent asset to have. For this type of investment, the risk is moderately high, but the time and capital requirements can be significant. – despite this, if you are renting your unit out, this will easily make a return for you as a more passive income.

Foreign currency

Foreign exchange investment is one of the most skilled investment vehicles, because of this the risk management required is high. This method isn’t recommended for beginners under any circumstances.

Read our article about Forex

Commodity products

In investment terminology, naturally occurring raw materials used in different industrial sectors are referred to as commodity products. Examples of commodities would be gold and oil. In addition to foreign exchange trading, this is the other group of investment assets that requires a higher level of expertise and large time expenditure and can be very risky.

Cryptocurrency

Virtual money has recently become a very popular investment vehicle due to its return potential. Although it should be noted that there have been numerous instances of regular, unexpected crashes and unpredictable behaviour of cryptocurrencies that you can readily find information on.

Bearing all of the above in mind, cryptocurrency trading is a particularly risky area of expertise.

The easiest way to diversify investments?

The easiest way to diversify is through investment funds. The advantage of these is that by buying a single asset, you practically put your money in a diversified portfolio. For example, with a fund, you can choose an investment fund based on geographic regions (e.g. USA, Far East, Central Europe, etc.), raw materials (gold, oil), risk, or even sector. Each fund has dozens or even hundreds of securities, which also supports diversification.

In addition, this way you can diversify much more cost-efficiently than buying each of the securities, found in any chosen investment fund, separately. And further to the fact that these assets are completely liquid, a whole team of experts is engaged in achieving the best possible return on it.

Putting savings in investment funds can also be solved within the framework of your pension insurance in the form of life insurance tied to investment units

Is there such a thing as excessive diversification?

Diversification is very important in creating a balanced investment portfolio, but it can also be overdone. One of the disadvantages of excessive diversification is that the investment system can easily become overbearing for any investor. If you don’t know exactly what your money is doing and what or where losses have been made, and where to focus your attention, you may lose control of your money.

Another downside to excessive diversification is relatively low yields. Figuratively speaking, the more legs you stand on financially, likely there will be less capital allocated to each product. This is why, most of the time, these lower yields can be expected. Not only this but, lower capital allocation also means there is less risk of you losing a large proportion of investment in one go, without diversification you could even lose everything all at once.

However, this does also mean if one asset fund generates high returns, you will benefit less from it because of the smaller amount invested than if you put a larger amount into it.

This reduces the relative return on diversified portfolios, but in a balanced investment system, the strengthened portfolio security offsets this lower yield potential due to reduced risk, and therefore reduced losses.

Conclusion

As in other areas of life, it is very important to reduce the risk in finance and it can be detrimental to keep our savings and assets all in one place: whether it be in an account, in a bank account, or in the shares of one particular company. However, with a balanced portfolio of investments managed very carefully either by you or by experienced professionals, you can be sure that your wealth grows in the long term and provides you with financial security.

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In-depth Investing for Beginners: How Does It Help Build Wealth?

21 minutes to read

Are you intrigued by the concept of investing and want to learn more about investments? Then you’re in the right place!

This article will present the most important investment basics, that beginners need to know. We will also look at why investing is beneficial and what you may miss out on if you don’t take advantage of it.

If you want to build wealth — either for retirement or to achieve financial freedom — usually, it isn’t enough to make money and save some of it.

As Robert Kiyosaki said, “For every dollar you save, you can give a work suit and send it to make more money for you.”

Today, anyone can invest, with a few hundred dollars and a phone with an internet connection, anybody can get started.

However, the world of investing can seem complicated, and we often don’t know how to get started in the first place. We can find ourselves in a real sea of jargon on the Internet, where sometimes it is difficult to find the best of the available information.

Because of this, many people don’t even start investing and so, due to inflation, they continue to lose money without even realising. With the right basic knowledge, investments can be made to be much more simple.

This article will give you all of the most important information that you would need as a beginner starting out on your investment journey.

As there is a lot of information packed into this article, please see our Table of Contents below:

1) What is Investing?

1.1) 1. Cash flow / Direct income

1.2) 2. Capital gains

1.3) 3. Cash flow + Capital gains

1.4) Investment means the purchase of income-generating assets

1.5) The Difference Between Investing and Speculation

1.6) Investor Vs. Speculator

2) Why is it important to invest?

2.1) Why is it not enough to save?

2.2) Build Wealth With the Power of Interest

3) When should you start investing?

4) Misconceptions about investing

4.1) Myth 1: Investing is Difficult/ Complicated

4.2) Myth 2: The Luck of Investing

4.3) Myth 3: It Takes a Lot of Money to Invest

4.4) Myth 4: Only The Rich and Professionals Can Invest

5) Investment Funds

5.1) 1. The Main Asset Classes

5.2) 2. The Correlation between Return On Investment (ROI) and Risk Exposure

5.2.1) High Yield, Low Risk?

5.3) 3. Diversification

5.3.1) Think in portfolio

5.3.2) ETFs: One of the Best Tools for Diversification

6) Investment Concept: Summary

What is Investing?

By investing, we mean a long-term process of buying income-generating assets with the aim of earning a return from it in the future.

Self-made money-man Warren Buffett once said:

“Investing is giving up today’s consumption in order to consume more later.”

Where does the return / gain come from?

It can come from three different sources, as explained below, where we will use examples to illustrate the given point:

1. Cash flow / Direct Income

Example #1: When you invest in a company’s shares, you actually become one of its shareholders.

As incredible as it is, when you buy an Apple share, for example, you’ll be a part-owner of the company, even if you’re going to own only a fraction of the shares issued.

From the profits generated by Apple, you, as a co-owner, receive dividends on your shares every quarter.

Example #2: If you invest in a property and rent it out, you’ll get a monthly wage fee in return, in the form of the rent you receive from your paying tenants.

2. Capital gains

The prices of both shares and property can rise, from which you can achieve capital gains.

Example: If Apple performs well, the price per share will increase. Let’s assume you bought an Apple stock for $100, which later increased to $150. In this case, you would have made a total capital gain of $50.

3. Cash flow + Capital gains

For many investments, you can get your returns from both sources. In the case of shares, you can receive dividends (although not all companies will pay dividends) and capital gains.

In the case of real estate investment, in addition to the monthly wage fee, the price of your property may also increase.

Investing Means Buying Income-Generating Assets

It’s no coincidence that we highlighted “income-generating” assets above. Colloquialism and the media often misuse investment as a concept.

For example, you may often hear people remarking that they have invested in a new car or a new phone.

For these purchases to be considered an investment, we must ask the following question:

Is this ‘XYZ item’ going to produce any future returns?

If the answer is no, then the new purchase is not an investment at all but instead is known as an ‘obligation’. This is because it may incur maintenance costs, but in turn won’t subsidise the user for these costs in any way, meaning they will be out of pocket.

Another thing to consider in this case is that the item’s value is also constantly depreciating (falling).

As we have said, buying a car for personal use is not an investment; it is a cost. But this can be changed if, for example, you were to start a courier company from which the vehicle will become a means for you to earn from.

Contrary to popular belief, trading, Forex and cryptocurrency purchases aren’t actually considered to be investments. Instead, these are officially known as speculations.

The Difference Between Investing and Speculation

Despite there being critical differences between these two concepts, it can be difficult for beginners to distinguish between the two, this is also true for those who are more experienced.

According to the world-renowned investor, Philip Carret:

“The man who bought United States Steel in 1915 for $60 to profit from the sale at a higher price is a speculator. In contrast, the gentleman who bought American Telephone to get a dividend yield of more than 8% is the investor.”

Carret also, quite concisely, said the following:

“Speculation is the purchase and sale of securities or commodities merely in the hope of profiting from their exchange rate fluctuations.”

As one of the greatest investors of all time, Warren Buffett’s example reflects the difference between speculation and investment:

“There are two types of devices that can be purchased. One is where the asset itself generates returns for you, such as rental properties, shares, or a farm. And then there are devices that you buy in the hope that later someone will pay more for them, but the devices themselves will not produce anything for you. I think the second is speculation.”

Our take-away from this is an investor thinks in the long-term and buys an asset because of its future cash flow. Here the assets primary purpose is to keep your invested capital safe while achieving adequate returns simultaneously.

Opposite to this, a speculator buys a particular asset merely in the hope that its price will increase (or fall) due to market sentiment, regardless of whether the fundamental value of the underlying asset has changed.

Investor Vs. Speculator

The most critical differences between investment and speculation are the level of risk exposure and the certainty of retaining any invested capital.

In this case, the investor is more assured that they will not lose their money, whereas the speculator should know that there is a high probability that the investment can be lost entirely.

The problem is when a person believes they’re investing when they’re speculating, possibly causing some unexpected losses.

So, why would people speculate when they know the probability of loss is high?

The answer to this could be for the same reason that many people like to gamble – some may think speculation is exciting due to the, sometimes high-stake, risk, and that investments are boring in comparison.

To clarify, there is no issue with speculation, should you wish to put some of your capital here, but we must make the point that, if you wish to build wealth, then this might not be the best way to go about it (at least until you gain some market experience dealing with risk).

The best, most safe and proven way to build wealth for a beginner may be to invest.

In the world of personal finance, the general consensus is to never speculate more than 5% of your total wealth.

Why?

In the event that you lose everything that has a high-risk probability, it won’t have a big impact on your financial situation due to your other portfolio assets.

Why is it important to invest?

Since investments also involve certain risks, from time to time the question of whether it is really worth investing in the first place may arise. And, it may also be asked if there is a better alternative? Let’s look into this:

Why is it not enough to save?

Saving is the number one and most important element in achieving your financial goals, but without investing you won’t get much out of your money, depending on a number of variables.

The purchasing power of the amount held in fiat currency (Liquid cash) and that held in a bank account, is steadily decreasing due to inflation.

Many people don’t realise this fact. For example, if you set aside $10,000 today and don’t touch it, you will likely still see the same amount in your bank account in 20 years. The problem in this is that, due to inflation, in 20 years this amount will carry much less purchasing power. Meaning its value has steadily decreased throughout the years.

By investing, however, you can maintain the purchasing power of your money against inflation and increase it at the same time.

This is well reflected in the chart below, which shows an inflation-adjusted value (Real value) of $1 held in various assets (e.g. stocks, bonds, gold or cash in dollars) between 1802 and 2012.

It is clear that if you invested in stocks, for example, your initial $1 investment increased to $1,029,045 (above inflation!).

Conversely, if you kept your money under your pillow (DOLLAR), the initial $1 dropped to 0.051 cents due to inflation.

So you didn’t do anything, and yet you lost — you couldn’t even keep the value of your money.

Therefore, to answer the question posed at the beginning of this section: yes, where investing does involve risk, the alternative is guaranteed loss.

Build Wealth With the Power of Interest Interest

If you want to build wealth, whatever the reasoning (e.g. providing a good pension, building passive income or achieving financial freedom) – investing is necessary for achieving this goal.

You can increase your money by buying income-generating assets. You can then use the funds generated by these assets to purchase further additional assets that will, in turn, generate even more money. You can even continue to reinvest earnings infinitely if you want to build the portfolio quicker than you would otherwise be able to do so.

As Ben Franklin said, “Money that money produces, produces money.”

Thanks to compound interest, as you continue to reinvest earned capital, your wealth will begin to grow at an ever-accelerating rate.

Read more about compound interest and use our compound interest calculator to see how much return a month / year you can make. Click Here

The following illustrates the effect of interest rates:

As you can see, over time, an increasing and larger portion of your wealth is made up of yield (part marked in purple).

By the end of the 20 years, your total wealth was about $7000, of which you only invested about $1000.

When should you start investing?

This Chinese proverb. Although it has its own applications, it is very much true for investments too:

“The best time to start planting a tree was 20 years ago. The second best time is today.”

Why is this relevant?

The earlier you start investing, the longer you can utilise the power of interest rates.

Let’s make three examples; Michael, Jennifer and Sam.

Michael started investing $95 a month at the age of 25, for 40 years until he was 65.

Jennifer began her investments 10 years later, depositing around $126 per month, for 30 years until she was 65 years old.

Sam discovered the investments very late, meaning he only started investing at the age of 45. Because she was so far behind the others, she decided to double Michael’s monthly deposit, so Sam invested $190 a month for 20 years until she was 65.

So all three invested, on average, the same amount – that is, $45,600 – all across different time horizons.

The question is, who made more?

Let’s look at:

Note: Image is for illustration purposes only and doesn’t reflect mentioned figures

Even though all three investors allocated the same amount over time, Michael was the one who ended up with the most considerable capital.

He enjoyed the power of compound interest for the longest time, so even though Jennifer and Sam invested the same amount, Michael’s money worked harder than the other invested capital amounts.

Why? Take a look at our Compound interest calculator here to see how it works for yourself!

Misconceptions about investing

Many people have certain misconceptions that will stop them from getting started altogether. So let’s begin this section by dispelling the most common misconceptions you may encounter.

Myth 1: Investing Is Difficult Or Complicated

Sometimes, the financial sector may try to overcomplicate investments in the hope that clients will be overwhelmed with all the information and will, therefore, need to make use of their advisory services.

The truth is that with just the most basic knowledge, investments become quite simple; You can acquire the basic knowledge required for it with just a few hours of learning.

Investing will always seem complicated when you don’t understand it in one way or another. But unfortunately, this is just a natural part of human psychology where a lack of understanding will be confusing.

Myth 2: The ‘Luck’ of Investing

Many people don’t invest because they have wrongly learned that investing is just the same as, if not similar to, gambling. However, certain assets, such as cryptocurrencies, do happen to be a little closer to gambling when we compare the levels of risk, which usually creates this misconception.

So what separates investment from gambling? There are many ways in which these two topics differ from each other, although here are the main three distinguishing factors of investing:

With your investments, you have control over the level of risk exposure, and you can also limit your level of loss. Unfortunately, in the case of gambling, you don’t necessarily have the luxury of controlling these factors, meaning you can only win or lose everything.
When you invest, you essentially become the owner of that particular asset, for example owning real estate or becoming a part-owner in a listed company (stocks). When gambling, you don’t own anything once you have assigned your capital to it.
Before investing in any particular product, there will usually be a lot of information (often decades-worth) that you can first analyse to make reasonable and informed decisions. On the other hand, gambling will often not be able to offer this opportunity beforehand

Myth 3: It Takes a Lot of Money to Invest

Depending on the paltform, you can start investing from $10 today, so this misconception is also silly.

Moreover, you can use even smaller amounts of money to build significant wealth in the long run, thanks to the power of compound interest.

However, the important thing is that you start at the earliest moment you feel ready. With this method, you can gain invaluable investor experience with smaller capital mounts, meaning you can keep overall losses to a minimum in the long term.

These experiences will come in handy later in your investment journey when you have more capital at your disposal and start to invest more. If you’re not sure why using this method is helpful, the fact is you will make mistakes when you first start. However, learning from these instances, which produce more minor losses, and being able to apply the experience gained in future situations means you will be better prepared for more considerable risk exposure much quicker.

Myth 4: Only The Rich and Professionals Can Invest

Many people believe that only the more privileged of people can invest. This couldn’t be further from the truth.

Even if this was once true, practically anyone could invest in today’s market. We can say this is regardless of age, income or professional knowledge. And as we previously stated, it can be more beneficial in the long run to you, as an investor, to begin your portfolio with smaller capital amounts.

The Investment Funds

This section will look at the most important basics that you need to know about investments.

1. The Main Asset Classes

There are many investment options. We can classify almost all of these options into a corresponding asset class; An asset class is a group of financial instruments with similar characteristics.

A) Cash and cash substitutes (cash, T-bills, savings accounts)

This is the more simple of the groups, with the lowest risk management requirement. The primary advantage of such investments is high liquidity (immediately available or easy to convert into cash), with a maturity of up to 1 year.

Cash and bank deposits are included here, as are securities such as the Treasury-Bill (T-Bill) issued by the U.S. state, which is internationally recognised and often used as a risk-free interest rate.

B) Fixed income (bonds, government securities, bond ETFs)

It is an investment in debt securities. These are known as fixed incomes because securities offer investors a fixed interest payment within a specified period.

Fixed income is usually simply referred to as “bonds.”

C) Equity (shares, mutual funds, equity ETFs)

The term ‘equity’ derives from the fact that shares are equity securities. By investing in listed companies, we – in turn – become part-owners (or shareholders) of that company.

Through something called an ‘Exchange Traded Fund’, otherwise known as an

ETF, we can acquire shareholdings in a pre-prepared selection of companies at once instead of deciding what companies to allocate our money to one at a time.

An example of a more popular, and more importantly, proven ETF would be the S&P 500, the US index.

D) Alternative investments

As other financial instruments are commonly referred to as “alternative investments”, Real Estate; Commodities; Forex, Hedge Funds, Private Equity, and Derivatives are included in this asset class.

2. The Correlation between Return On Investment (ROI) and Risk Exposure

One of the main principles of investment is that return and risk go hand in hand.

This means that investment opportunities offering higher returns are associated with higher risk at the same time.

In the same way, low-yield investments offer greater certainty because of their low risk.

The following chart shows the yield-risk relationship between investment opportunities within different asset classes:

Both bonds and stocks are good examples of the point that we are trying to make here.

The risk of shares is higher than that of bonds. This is due to the fact that shareholders have what are called “residual claims”. This means that when it comes to any profits a company makes, creditors are paid first and then the shareholders. Meaning that, if the company is profitable, a policyholder’s returns are guaranteed, whereas those expected by a shareholder aren’t so certainly ascertained.

Further to this, in the event that the company goes bankrupt and is liquidated, the creditors’ claims are first satisfied from the assets sold and only after this has been done – and shareholders will only be paid if there is anything left.

Meaning when the liquidation of a company does unfortunately happen, shareholders often get nothing.

As referenced earlier in this section, because shareholders take on higher risk, they also expect higher returns in return.

In another example, government securities have a lower risk against corporate bonds, since the security of our capital depends on a state’s ability to repay us, compared to this companies carry more risk.

Of course, there are exceptions to this. An Apple bond is much safer than, say, a Ugandan government bond. This is because smaller countries carry more risk.

High Yield, Low Risk?

A recurring question you may sometimes hear, or even ask yourself is; “How can I get a high return with low-risk exposure?”

Unfortunately, there isn’t such a thing, at this moment in time, that can be utilised.

If there were, it would be an arbitrage situation that investors would understandably take advantage of very quickly and so it would disappear in the blink of an eye.

For example, imagine an extreme situation in which the yield of an almost risk-free government bond is higher than the yield of a stock, which carries a much higher risk;

Institutional investors (whose thousands of employees and computer algorithms constantly monitor the market) would immediately start buying government securities, as it has become quite attractive compared to other investment opportunities. This would increase the demand for government securities and therefore the price.

A higher price would simultaneously mean a lower yield, thus correcting the yield on government securities to the point where it reflects its risk.

So if you want to get a high return, you have to take a higher risk.

3. Diversification

While the risk of investing cannot be completely eradicated, it can be reduced by avoiding unnecessary risk.

You may have heard the saying, “Don’t put all your eggs in one basket.” This is very relevant here.

Many people make the mistake of investing all their money in one particular company’s shares. If you were to do this, and something happened to your chosen company, you could lose a lot of money or even potentially lose all of your invested money.

Think in Portfolio

Instead of individual stocks or bonds, you may want to consider a portfolio that is more broad and diversify your investments across different asset classes.

This will make the performance of your portfolio less dependent on the performance of a single asset class, which will:

Reduce the risk of your investments
Increase the return on your entire portfolio
With a well-diversified portfolio, you can achieve a much more favourable return-to-risk ratio.

As we have already seen, each asset class has its own unique feature and they each have an individual reaction to different market changes.

In general, where one asset class performs poorly, another will moderate or offset it.

Example: In times of crisis, when stocks tend to fall sharply, bonds can provide security, thus balancing the performance of your portfolio.

Not only should you just diversify between asset classes, but it would be beneficial to at least consider diversifying the products bought from within the same asset class.

Example: Instead of just one company, you can invest in many multiples, allowing you to spread your risk a lot more.

As you can see, you can diversify on three levels:

Between asset classes
Within asset class between different, individual investments
Between different regions and industries

ETFs: One of the Best Tools for Diversification

The following question is a great one, not to mention reasonable to ask:

“I don’t have the money to buy hundreds of shares. In fact, I don’t have the time or knowledge to properly manage them. What should I do?”

There is a saying about finding a needle in a haystack. There is also a continuation to it which says, “Instead of looking for the needle in the haystack, buy the whole haystack instead”

With ETFs you can buy the whole haystack, figuratively speaking anyway.

With a single purchase you can buy into hundreds or even thousands of shares for any amount you can put aside. Minimum amount can vary platform by platform on eToro you can start investing from $10

Investment Concept: Summary

We’ve all heard that we should invest, but many people don’t start. Many are held back by the potential investment risks.

Investments can be risky, but if you invest according to a well thought out investment strategy, you can reduce these risks and have a fairly higher degree of certainty that you won’t lose as much as someone who doesn’t have a set strategy.

Don’t forget because of inflation, if you don’t invest, you are guaranteed to experience some form of a loss.

So therefore investing remains the most beneficial way to achieve your long-term financial goals of building wealth.

While investing may seem complicated at first, with proper research, it will surely become a lot more simplistic and can show good returns.

Have you invested before? Or perhaps you are currently studying and plan to invest in the future?

Whichever situation you are in, we hope that we have been able to cut the jargon for you by clarifying the truths of investing.

Please understand that NO information in this article should be considered investment advice and should only be used as a guideline.

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BEST INVESTMENT SINCE 1927: SMALL VALUE SHARES

10 minutes to read

Our article will look at which shares would have made us the most profit if we had bought them between 1927 and 2019. We will talk about the so-called small cap stocks and discuss how much these stocks outperformed the U.S. stock index, the S&P 500.

We will also talk about how much differently these stocks have performed over the past decade and how well this could mean small value stocks may perform in the future.

Our topics:

What was the result of small value investment between 1927 and 2019?
What does small value stock mean?
Value-glamour anomaly in the stock market
How value shares outperform periodically

What was the result of small value investment between 1927 and 2019?

If we look at the yield on small value shares in Professor Kenneth French’s Research Portfolios database, we find that the annualised return on small value shares was 14.5% between 1927 and 2019. Meaning small value stocks outperformed the S&P 500 index by 4-5% annually, with a yield of 10.2% in the same period. So you could say that small value stocks have been the best investments in the U.S. stock market for the last 80 to 90 years, but over the last decade, the value factor has underperformed the stock market, which affects small value stocks well.

The problem with the above comparison is that we compare stock indices. Still, we cannot invest directly in stock indexes, so we get a more accurate picture when comparing specific investment products. For this purpose, I raised the Vanguard Fund Management S&P 500 Index (VOO) (VFINX) and the VB (DFA) US Small Cap Value etf.

The graph below clearly shows that the small value portfolio (11.37%) outperforms the S&P 500 index (8.03%) between 1994 and 2012.

But after 2012, small value stocks (10.85%) are lagging, with the S&P 500 index outperforming by 14.73%.

However over the past decade, small value stocks – and practically the value factor – have diminished the stock market’s impact. We have considered the possible causes of this change, so let’s look at what small value shares mean.

What does small value stock mean?

A ‘small value share’ is a term for any shares with a low market capitalisation, i.e. small companies, and are underpriced based on various fundamental indicators (e.g. P/E – Price-to-Earnings ratio, P/B – Price-to-Book ratio, P/S – Price-to-Sales ratio, P/FCF – Price-to-Free Cash Flow). Investors are actually exploiting two stock market anomalies by investing in value shares; because one only invests due to the size factor, i.e. low-cap stocks have a premium yield.

Between 1927 and 2010, the average annual return on shares with the largest market capitalisation was 10%, while the average yearly return on shares with the smallest market capitalisation was 21.26%. When the U.S. stock market was split into ten different parts. This defined the largest and smallest stock categories, according to their level of capitalisation.

The smallest category of shares became the lower deciles. In contrast, the largest market capitalisation became the upper decile, meaning this group is the top 10% of shares with the largest market capitalisation. But this anomaly is observed not only in the case of shares with the most and least significant market capitalisation but continuously it has been shown that those with smaller caps can make a higher possible yield; see picture below.

For example, the 50% of shares with the smallest capitalisation would show an average annual return of 17.24%, if the value of all U.S. stock was to be halved. In contrast, the 50% of shares with the highest capitalisation would only offer a return of 13.32%.

The other is the value factor, i.e. purchasing underpriced shares on the basis that their future value will out-perform. This value factor is based on well-known investors, such as Warren Buffett’s investment methods, but backtesting has shown that the value factor is a common element even in long or short techniques.

However, the problem is that the impact of the value factor has diminished over the past decade. As a result, some indicators may no longer achieve any additional returns (yields that outperform the S&P 500 index), but some other indicators still prove effective. In any case, these are the reasons behind newspaper articles in which you read that Warren Buffett’s method of investing, or value-based investing, has failed, it is not working.

Value-glamour anomaly in the stock market

The truth is that different premiums on the stock exchanges have changed over time. As an example, let’s mention the most well-known premium, the risk premium of the stock market, which also forms the basis of the CAPM (capital Asset Pricing Model) and shows a decades-old correlation, i.e. investors receive a return premium in exchange for equity market risk. This yield premium averages 8.24%, and at a stat value higher than 2 (3.91), indicating a statistically significant result. This is a robust, significant observation, and the value factor is similar.

However, in the case of the risk premium, we also find that it is not always positive. We will use the following periods: 1929 – 1943, 1966 – 1982, and 2000 – 2012 to highlight this. In all of these periods, the risk premium of the stock market was negative – the S&P 500 index would have given you a lower return than risk-free investments would have done. Let’s also discuss that, if we take an even more comprehensive retrospective look, there have been several negative risk premiums in the past.

As you can see, not so long ago,the risk premium was negative in periods of 10-12 years, therefore the fact that the value premium has been negative for the same length of time, is a trend more than it is a surprise. The presence of this extended period isn’t a surprise, simply because stock markets have longer cycles, but as you can see in the graph above, the value premium averages 4.7% per annum.

We have also talked about the reasons behind the underperformance of value shares, and in this article the so-called value-glamour anomaly also appears, i.e. popular growth shares (glamour) underperform the shares selected based on their longterm value, but it is still possible that growth shares can outperform in the short term.

Value shares outperform periodically

It is worth being aware that the returns available on the stock market and stocks also change over time, so while it sounds reasonable that the yield of the S&P 500 index is 10% per year, this average is calculated over a period of 90-years. Over a shorter investment horizon (e.g. 5-10 years), yields are significantly spread relative to the average, depending on valuation.

The graph below shows the P/E ratio (Price-to-Earnings ratio) of the S&P 500 index over the past 25 years. Over the past 25 years, the average P/E of the S&P 500 index has been 16.39. The graph also shows the boundary of single standard deviation (13.24 and 19.54) with dashed lines, i.e. assuming a normal distribution, the P/E ratio moves in the range 13.24 to 19.54 for 67 per cent of the period. And if the P/E rate leaves this band, we will see a level of appreciation that is relatively rare (33% of the time).

If we look at the double standard deviation, the P/E ratio varied between 10.63 and 23.23 in 95 per cent of the period.This means that above 23.23 (now 21.72), we will witness a rare event with a probability of 5% based on data from the last 25 years.

The problem is that a high P/E ratio predicts low future returns. For example, in the photo below, you can see the 1-year forecast. The descending yellow line shows that with the increase in the P/E ratio (on the X axis), the available annual yield falls (Y axis). The problem is that the standard deviation of the data is substantial. In some years, yields are very far from the yellow curve, i.e. the indicator is unsuitable for an annual forecast (the correlation factor of 9% indicates this).

In the case of forecasting five-year annualised yields, the forecast is much more accurate. The standard deviation of the data is smaller, but this also shows us the above correlation. Or a more accurate (80% correlation factor) is the Shiller P/E ratio.

The essence of the above is that the rise in the stock market is typically driven by growth shares, so value shares underperform in the mature phases of a bull market when it comes to the stock market. You can see an example of this in the graph below, where you can see an index in yellow showing the largest 1,000 growth companies in the U.S. stock market. In grey, is the most sizeable price of 1,000 value shares.

It can be clearly seen in the picture above that in the bull market preceding the dotcom bubble, growth shares outperform significantly, and then by the end of the crisis, they fall back to the same level as value shares. This is followed by the period when value stocks begin to outperform.

And then, over the past 10 years, growth stocks have outperformed strongly, and the gap will widen spectacularly after 2015. At present, the P/E ratio increase correlates with growth shares’ price increasing.

And if we compare the valuation of value and growth shares, we can see a similar situation. In the picture below, you can see that before the dotcom bubble (2000), growth shares will become more and more expensive fundamentally (downward curve). Then the valuation of growth shares will again approach reality (falling prices on the stock exchanges, this will improve the P/E ratio). However, over the past five years, we have seen that growth shares have become more and more overpriced, when compared to value shares (the curve is falling).

Therefore, we have seen that growth shares outperform value shares over time in certain periods. However, over more extended periods, value shares usually outperform. There are also logical reasons for the overperformance of growth stocks; think of the irrational behaviour of some investors in the stock market. Even in longer periods of time, momentum drives up prices, but this results in an overpriced situation (and in-turn predicts lower future returns).

The bad news for investors is that such overpriced situations can persist for years, and as previous examples show, there’s nothing special about an effect not working on stock markets over a 10-year horizon. Of course, small value and value shares may outperform again sooner or later, but this will have to wait.

The topics that we have/will cover are: stock market trading, stock market investing, correlations that could result in additional ROI, facts and misconceptions about the Stock Exchange and stock market anomalies, as well as many more!

Before considering investing in small-cap stocks you should do your own research (DYOR) on them. To help get you started, we have found a great article that will bring you some extra knowledge.

Risk Management for Forex and CFD Trading

8 minutes to read

Learn the best risk management practices for successful Forex and CFD trading.

In order to trade Forex and CFDs, leverage is needed, and it can greatly multiply your profits. Due to the risk associated with leverage, though, your losses can be significantly increased too. The higher the potential profit, the greater the risk, so it is a prerequisite for your subsequent trading to understand the risks of leveraged trading. Your guide to Risk Management for Forex and CFD Trading.

As we said, Forex trading does have high risk. Thankfully, in many ways, you can lessen this.

This article will guide you through the basics of applying risk management strategies. Please note that this is not financial advice, and we are merely providing an informative resource for you to educate yourself on this topic further.

What Does Risk Management Mean?

General trading risks

Your profit opportunities are always closely correlated to market risk.

Think of risk management as a package of assets and activities that you can use to keep your losses low and potentially increase your profits.

Risk management in Forex trading is based on the following four fundamentals:

Identifying the risks of Forex
The analysis and assessment of these risks
Solving ways to reduce the level of risk
Consistently using these solutions with careful management and consistent utility

Examining markets is a priority for both novice and experienced traders alike. Finding a good market “entry” is vital. However, this doesn’t lessen the value of risk management has, for professional and new traders alike.

We also wrote an article about market risk specifically click HERE to read it

Leverage effect

Most people choose Forex and CFD trading because of the possibility of leverage. Why? Because with leverage, we’re going to have a much smaller margin requirement, with less capital – this helps produce a more significant profit margin.

REMEMBER; If the market doesn’t go your way, you could lose a lot more!

The more leverage you use, the faster you can win or lose. For example, there is a chance that you could choose leverage higher than you can handle. If this were to happen, it could cause you to no longer manage your assets sufficiently, potentially causing losses. Less leverage can be an attractive option to reduce your risks, but, at the same time, any potential profits would deflate because of it. Therefore, it is worth carefully considering the degree of leverage you have.

Incorrect market valuation

Trading Forex pairs, CFDs begins by deducting spread costs (difference in buy and sell price). Immediately after opening the position, there will be a negative value in your profit column. You should be aware that your trade will not always be profitable. It doesn’t matter how much you lose. To keep losses within reasonable limits, you should set a stop loss. However, remember that setting the “stop-loss” too narrow will mean your position may be closed even with minimal market movements.

Remember, not all positions will close in the green (profitably).

Rapid market movements

The market continuously moves because of news, opinions, trends, and political decisions.

For example:

Suppose a central bank announces that it is changing the interest rate. In that case, this suddenly causes considerable movements in the markets, and significant gaps (breaks) in the exchange rate may appear very quickly.
A prominent market participant may intentionally cause market ‘pain’, generating a significant downward shift by liquidating specific, more prominent positions.

Sometimes there may be unexpected market movements. Even if you feel like you are constantly watching what is happening, you can never know precisely what will happen in the next few minutes.

What do we suggest for that?

You may want to use automatic tool systems, such as stop-loss and take profit parameters, to close your positions on time for you. However, it is essential to know that inputting a stop loss does not promise to eradicate the possibility of loss completely; it can only limit how much loss you can suffer.

Market gaps

Suddenly the exchange rate jumps, which is clearly evident on the chart.

A gap usually occurs after the market closes, but there are situations when the exchange rate reacts to unexpected economic news or events in the case of an open market.

Why is this important? If such an open market gap is created, the set stop loss and take profit levels will only be executed with the closest exchange rate available. An example on the EUR/USD graph:

An unusually large weekend gap emerged on this chart
There is no bid/ask within the gap, which means that the stop loss placed is only triggered at the nearest exchange rate after the gap.

The presented gap on the chart shows a negative slide in Forex Trading rules. But, of course, there is also an example where slippage can result in a higher return for the client, since the profit taking has been achieved in a more favourable place.

Risk management tools

Stop loss – know your limits

Prices can move very quickly, especially if the market in a period of volatility or nervousness. Therefore, a well-placed stop loss “reacts” much faster than any manual trader would be able to react, making it one of your most serious risk management tools.

Countless articles and articles have been written about choosing the proper stop loss, but there is no golden rule that can apply to all traders and their different trades. The appropriate stop loss location for each trade must be determined separately by answering the following questions.

What is your trading timeline (just know – for a longer-term position, there may be more volatility)?
What is the target price, and when can we expect to reach it?
What type of account do I have, and what balance do I have on my current account?
Do I currently have any open positions in the market?
Is my position size appropriate for my account size, balance, trading timeline, and market situation?
What is the general market sentiment (volatility, liquidity, news, external factors)?
How long is the market open (e.g. is the weekend is approaching or when will the market closing be happening in the evening)?

Since there is no general rule on setting up a stop-loss, we recommend using a free demo account so that you can learn to get to grips with proper implementation without any real risk happening to you. Here are some trading examples of different stop loss uses. If you have a real account, you can use MT4’s extended trading features in the same way, which displays the risks associated with each stop loss in the specified currency.

Position size

Even the best of traders can experience non-profitable positions. For example, ending with 5-8 out of 10 trades positive is considered a successful ratio in Forex Trading. Therefore, a well-chosen position size is critical to get through any market movement.

Select leverage

As you already know, too much leverage can increase your risk, and even a few negative trades can ruin your good results. So, we want to remind you:

To choose the right level of Forex leverage for you, and don’t get in over your head.
use our trading calculator in MT4 Supreme or on our website to see different trading situations, which will help you later choose the right position size for your live trading.

External factors

Keep in mind that several external factors can affect your trading strategy on Forex. Such factors:

power outage and/or internet connection problem
you are busy or hijacked by office work.

Try our trading calculator to practice different trade scenarios.

(Try the trading calculator)

Be aware of the picture as a whole

Forex and CFD trading can provide substantial profit opportunities when buying or selling. But remember, it can also cause losses if you don’t practice and learn risk management. Identify your weaknesses and manage them. This will be what will help control your losses – even if you have 8-10 winning trades, just one single losing trade can absorb all of those profits.

We know that the psychological factor in a loss-making trade can discourage many novice traders. But it is essential to understand that loss is part of trading. So, before you start your first live trade, understand:

Losses are inevitable
And know how to process them psychologically before they happen.

This guide is intended to facilitate the trader’s risk management with descriptions and examples. As well as what tips we offer, we ask that you do these two things:

Keep this fundamental information in mind as you improve your personal risk management strategy
Understand that the information we have provided here will only help you to limit your losses – it will not solve them.

But listen, remember, Forex and CFD trading isn’t Heaven and Hell itself. You can significantly improve your profit/loss ratio for successful trading by selecting the correct risk management methods and applying them consistently.

You can try Forex trading risk free with a demo account. There are many brokers out there that we could recommend, one of which being Etoro.

HOW TO BE A SUCCESSFUL INVESTOR

9 minutes to read

Several helpful principles could assist in achieving desired portfolio results and become a successful investor

If you follow, or even at least consider, these nine investment principles, your portfolio will undoubtedly thank you:

Invest simply

Avoid emotive decisions

Keep out-goings low

Invest passively

Invest long-term

Appropriate risk distribution

Diversify

Be tax efficient

Invest regularly

Invest Simply

Although it may seem incorrect, the most straightforward investment solutions are usually the most profitable. Don’t complicate your investment strategy unnecessarily. Invest in such a way that you can understand your own strategy without too much effort.

Even the legendary investor and billionaire – and one of the richest men on the planet – Warren Buffett, followed a simple rule when choosing investments:

He only invested in companies that he understood, and companies whose products he encountered on a daily basis – Coca-Cola, for example.

Avoid Emotive Decisions

The biggest enemies of investments are the investor’s emotions and the so-called mental limitations that are characteristic of all people.

These natural limitations include:

Herd mentality

Subordination to mass consensus causes this and stems from the idea that a majority can’t be wrong. However, as history shows, it is one of the most dangerous forms of behaviour in finance, causing events such as bubbles, sell-outs and periods where there is fear of buying markets when they’re low, etc. Stay impartial to the market and be decisive – instead of eager to follow a ‘trend’.

Too much self-confidence

People tend to hold themselves in high regard and feel they can handle some things better than other people. To believe the following can be naive and will result in losses: ‘I can outperform the market, even though 99% of investors who have gone before me have not’. Try to keep your ego away from any decision making events.

Self-deception

In general, we often tend to (subliminally) choose to pay more attention to information that matches up with our own theories and opinions. Unfortunately, facts that go against our own ideas are likely to be put to ignored. This is also subconscious. Keeping as open of a mind as possible is crucial.

Fear of loss

Numerous studies have shown that we experience a surge of serotonin when we reach a profit- causing a positive mood boost. Although, opposite to this, the same studies also show that the fear of loss is three times stronger. Because of this, many people resort to the quick sale of profitable securities and retain loss-making positions. Adopting this strategy is not appropriate investment behaviour and should be avoided.

Mental myopia

This may be an unfamiliar term to some. Simply, it means that the small yet essential pieces of information that aren’t as obvious at first glance can be quickly forgotten or not even noticed at all.

Not only this, but current affairs and information that may signal a near-future threat tend to take precedence. Here, decisions are more short-term and can even be impulsive at times. An example of this mentality would be buying while prices are increasing and then selling when the price begins to lose momentum and reverses.

Financial studies have evidenced that a vast majority of individual investors produce lower returns than the market offers due to this series of natural behaviours.

To be successful in financial markets, you should not allow emotions to affect your investment choices. Minimise how much resolution, decision-making and intervention you undertake in periods of heightened emotion.

Keep Out-goings Low

Costs absorb a portion of your profits. The level of cost that you incur is critical to the positive or negative outcome of an investment.

If you want to invest successfully, we aren’t saying to avoid costs altogether, as this is next to impossible if you wish to progress. So, although costs are inevitable, just remember that the lower your expenses are, the higher your potential return could be.

Passive investment in the market

Passive investment would likely be the most optimal way to meet the three previous investment fundamentals successfully.

Passive investing essentially means investing regularly “buy it and forget it”. The advantage of passive investing is that it requires little to no intervention in the portfolio. So it’s more about the “buy and hold” strategy. The strategy does not seek the timing of investments or the selection of specific securities.

You can expect higher returns on passive investment due to reducing the risk of human error, as well as the minimal costs.

Increase your financial knowledge

The easiest way to make any particular investment successful is to take the profits offered by the market. There is a very low probability that you will achieve a higher yield in any other way in the case of a long-term investment.

The only caveat with this is being able to know when to take these profits. Therefore, through experience, you will learn how to best exercise patience and reason to get the most out of your investment when the time comes.

Invest Long-term

There is a saying that goes, “You walk slowly, and you will live longer” This phrase is more relevant in finance than any other aspect of life.

The key to success in investments is the interest rate. Thanks to this, the value of the investment increases faster every year.

Furthermore, the long investment horizon also reduces risk. Financial markets fluctuate from time to time, but they generally have historically moved in the same direction and have increased in the long run. The companies you invest in make billions in profits every year. This profit is always legally reversed in the company’s value (the price of shares), regardless of the market’s current mood.

Speculation is short-sighted, and no billionaire got rich because of it; they made their wealth with successful investment. The natural profitability of financial markets ranges from 8% to 10% per annum.

Logarithmic development graph of the SP500 index for the last 70 years. Average annual growth of 7.8%, with dividend reinvestment 11.34%

You can use TradingView to backtest assets.

A successful investor invests in the long term. They don’t give in to momentary worries or highs and adhere to the investment strategy. Short-term fluctuations in investment do not give rise to changes in their approach.

Appropriate Risk Distribution

To be satisfied with your investment, you need to know your relationship to risk.

The placement of financial assets means the distribution of different investment vehicles. Assets will differ in profitability and the risk associated with them. Historically, the most effective assets are shares, but their prices sometimes fluctuate more than bond prices, which offer lower but more stable profits.

The correct distribution of investments determines your future return and is an essential tool in passive investment.

There is no universally appropriate distribution. It differs for each investment and varies from investor to investor.

Invest like a professional.

There are a few different correlations between investor goals and portfolio composition when it comes to investing. The following strategies show this:

Choose more stocks and fewer bonds if you have a longer investment outlook.
If you want to invest most of your savings, choose more bonds.
If you have a higher appetite for risk, choose more stocks.

Diversification, i.e. the distribution of risk

Allocation is about the composition of an investment’s specific distribution, and diversification refers to its diversity. If you buy shares of 10 major oil companies, they are your allocation, but because the same ‘niche’ is the focus of the products, the portfolio diversification is much lower here. Portfolio diversification is important from several perspectives, especially for passive investment:

Reduces the risk

At some point, you have most likely heard the old saying of not putting all of your eggs in one basket. This saying talks about the fact that all of the eggs will break and therefore be wasted if the basket falls over. This ideology is how you should approach investing. The more assets in the portfolio, the lower the portfolio’s risk (since the loss of one of them is negligible when considering you will still have the rest of your holdings), meaning diversified portfolios are more stable.

Increases yield

No one can certainly predict which asset will have the highest return from year to year and which will have the most significant loss. Every year, the winner or loser is different for each asset class. The effort to invest exclusively in the winners usually produces worse results than the market. Therefore, the choice of a wide variety of devices is the most sensible.

Conditions for passive investment

Passive investment is about investing in the market.

All securities traded on a stock exchange or in that region represents the market.

If you want to invest in the market, it would be most beneficial to build a portfolio that has a similar composition as the market. Doing this would give your portfolio a high level of diversity.

Tax-efficiency

If you want your investment to reach the highest possible income, it is necessary to reduce the tax rate as much as possible.

There are separate categories within which you can find different asset classes and investment methods, along with varying tax pay classes. There are several ways to optimise your tax payments for investments.

It is essential that, when setting up your investment strategy, you keep in mind how it will cause you to be taxed.

Invest regularly

If you don’t have a large amount of savings that you can utilise here, don’t despair. Investing monthly with smaller amounts is perfectly fine – everyone starts somewhere, and it isn’t necessary to put everything on the line to be an investor.

From the point of view of budget planning, it is easier to set aside a small amount per month than to wait for a more significant, one-time capital amount to be put together. It is better to increase the value of your money correctly from the earliest available moment instead of being a bull in a china shop.

Moreover, regular investment is also interesting in terms of risk. When buying securities, you do not have to fear every month that the market will not fall shortly after the investment. A monthly fixed amount of investment reduces risk by buying more shares (cheaper) and vice versa (more expensive). This is known as Dollar Cost Averaging, which we have mentioned in a previous article

Investing regularly is an accessible solution which means that anybody can become an investor in their own right.

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