The Stock market can be a strange thing:
It can shoot up.
It can collapse.
And the Yo-Yo movement can make it seem to be acting completely crazy sometimes.
But when you have the right mindset and stick with a well thought-out plan it can be a tremendous wealth builder over the long term, growing your pennies into a stockpile for a future time, like collecting wood for winter.
One of the great things about a blog on personal finance is the chance to share a personal perspective on money-matters so I thought it worthwhile to share a real example of how understanding risk helped me grow my pennies in one of the craziest periods the market has ever seen.
I hope that by sharing this example you will have a better understanding of investment risk.
A Real-Life Example: Watching my investments drop in half.
I set out to grow my pennies initially by concentrating on simple index funds. I knew there were a million and one ways to invest in the stock market but sticking with an index fund (an investment than includes every stock in a ‘index’ like the FTSE in my case) would be a good start (more on this in future posts)
Of course, knowing I had such a long time horizon I began getting more curious about investments further away from home: particularly the mythical ‘emerging markets’ –investing in countries with economies that are set to grow in the future: like Brazil, Russia, India, and China (known as the BRIC economies).
After doing a bit of reading I decided to buy some units in a fund that focused on buying shares in companies in South America, primarily Brazil.
This was the beginning of 2008 before the full extent of the credit crunch was known so I had a huge surprise when, only days after making my initial investment, my investment valuations went into freefall!
Myth: Diversification avoids all investment risk.
Investing in a fund containing lots of different stocks and shares is much less risky than investing in only a few single shares, but it is still risky because stocks and shares in whole industries and countries can go down together.
You therefore need to make sure that before you make any investment that you think not only about diversification (how deep you go into stocks in terms of the range of investments) but also about asset allocation (how you spread your pennies across a range of assets –like cash, stocks, and bonds).
Asset Allocation is Important: For 20 and 30s somethings it means: Have you enough cash?
Thankfully I had already made sure my asset allocation was set –I had plenty of cash savings which helped me not to panic when my ‘emerging markets’ investment almost halved in a matter of months.
Those of us in our 20s and 30s can be much more ‘risky’ with our investments if we are investing money we won’t need for a long time –we can therefore give our money a chance to grow over the long term (with the possibility of significantly higher growth rates compared with a savings account).
Ultimately having a long term view and a good asset allocation has helped my investments to do well so far – as you can see I decided to buy even more shares at a lower price so as of now, my ‘emerging market’s investment has done very well for me.
Remember though, this could have been disastrous if I had needed to sell during 2008. In fact for many older people, the craziness of the stock market in 2008 was indeed disastrous to their life savings.
Lessons To Remember
My experiences in this investment also taught me an important lesson about asset allocation and greed.
- When you begin building momentum with your savings it can be tempting to invest as much as possible. However if I had been greedy and put all my money into investments at start of 2008 I would not have been able to invest much more money after the slump, nor would I have been able to touch that money in the event of an emergency without losing a huge amount.
- Being young certainly means we can take on more ‘risk’ but you have to be disciplined and rational about your long term plan if you want to be successful with your investing. Asset Allocation is just as important as diversification i.e. –prepare to spread your money around investments but keep cash on hand too!
It’s worth it though: from a long term perspective, as companies create value every day, stock market indices have always performed like someone playing with a yo-yo whilst walking up the stairs:
Up and down, up and down, but over time, you end up much higher than where you began.
Are you ready to begin the climb?