In my several years of experience of interacting with investors, I find that if there is one thing missing among most investors, it is self-realization.
In today’s story, let’s take a look at one of the most ignored aspects of investing; the need for knowing yourself before you start investing.
According to a great Greek Philosopher Aristotle “Knowing yourself is the beginning of all wisdom”.
Well, investing is like marriage. Because both require a long term commitment. In marriage, there may be initial hiccups just like volatility faced by investments in the short term. But with time, the bond of marriage becomes stronger, while investment tends to stabilize and give good returns when the magic of the power of compounding comes into play.
Now you must be wondering why this analogy between investing and marriage.
The reason is quite simple – when a person decides to get married, he/she looks for a person who matches their personality. So the entire quest for searching a life partner revolves around one’s one characteristic.
But sadly, the same approach is missing when it comes to investing. I see people asking more questions about the market, factors influencing the market and outlook of businesses. All questions are fine, no doubt. However, the starting point of investing should begin with knowing yourself.
So, which are the questions that you should ask yourself to understand yourself better?
Ask questions such as:
What are my financial goals and which are my short-term, medium-term & long-term goals?
What is my time horizon for each of these goals?
How much risk am I willing to take vis-à-vis the rewards that I will get?
So you see the first step in knowing yourself from an investor’s point of view is to decide your financial goals, decide the time horizon to achieve those goals, and decide the flexibility of those time frames if required.
Then, for each type of financial goal, an investor can decide on which kind of investment is best suited.
Before we proceed further, let’s take a detailed look at those questions which we mentioned above.
What are my financial goals?
Are you investing to save for a happy retirement or investing to buy a house or a car? Or is it because you wish to create a huge corpus to fund your child’s education or marriage?
It is said that “Setting up goals is the first step to turning the invisible into the visible”.
Hence, there are multiple reasons to invest, but as an investor, you need to be very specific about your financial goals. Once you’ve identified your goals, classify them as short-term (less than 1 year), medium-term (2-5 years) and long-term (5 years and above).
What is my time horizon?
Every goal has a different time horizon. For instance, retirement is a long term goal so that one can choose investments with high rewards but high risk. Whereas for short term financial goals such as buying a car or creating a corpus for your marriage, one needs to choose safer investments.
What is my risk tolerance?
It is imperative to understand how much risk one is willing to take. In simple terms, your risk tolerance means the degree of uncertainty you are willing to take to achieve potentially higher rewards.
To understand your level of risk tolerance, you can ask yourself questions such as:
Am I more concerned about losing money or losing purchasing power?
How much loss am I willing to bear?
Will I panic if my investments go down during a severe market correction or remain calm?
Will a particular type of investment cause sleepless nights for me?
The level of risk tolerance will also depend on factors like the number of earning members in the family. Along with this, your age, income, occupation, expenses expected in the future, etc. also should be considered. For example – if there is only one earning member in the family, the level of risk tolerance will be generally low, whereas if there are more earning members in the family, one can take more risks in their investment. Also, if you’re at the age of 30, earning modest and unmarried, you can take more risks as compared to an investor whose age is 60.
To conclude, when one’s investments are going up, it’s easy to assume that he/she is very risk-tolerant. However, the real picture is revealed when investments are sliding down. At this point, the investor’s true approach comes to the fore. Fears buried deep inside the heart can prevent an investor from taking risks to play safe, perhaps, but it also robs one of potential returns. A natural tendency to regret past choices may stop one from repeating past blunders, but it also stops one from retrying good investment strategies which simply didn’t work out the first time.
By better understanding how we feel, how we think, and what kind of personality we have, we get more insight into the forces that affect our investing behavior. And that might make us smarter investors.
That’s why it is essential to know yourself before you start investing. This will help you not just to make sensible investment decisions but also choose the best investments as per your financial goals.