Review the Fundamentals: 7 Basics to Investing

Your preparation to become an investor is not unlike considering any other profession or occupation.  There are basics and fundamentals that should be understood, if not mastered, in order to achieve your greatest success.

Let’s go over 7 fundamental concepts to general investing:

1 - Define a Clear Objective: Every dollar saved and every dollar invested should have a clear definitive purpose or goal. Your goal could be to acquire wealth for retirement, college, new car, and/or vacation. Your objective can be whatever you want it to be. It's simply important that you have a definitive goal. 

Establishing a purpose helps to determine where you'll save and how much you need to save.  This organization of funds also helps you determine your available capital to invest.  It is important to be goal oriented when saving and investing so you can achieve your potential.

2 - Time Horizon: Now that you have a goal and you're accumulating money to reach your goal. When will you need to access the money to fulfill your goal? If you'll need to access the money in the next year, it's not safe to tie this money up in investments at all. 

You're better off placing this money in safe conservative saving accounts, money market accounts, certificate of deposits, or money market mutual fund accounts. These types of accounts are also known as cash equivalents because they're relatively safe and easily accessible. If you won't need this money for five years or greater, you can consider investing in something with a greater return. 

Saving for retirement and other long-term saving goals is a little different.  Although you may access the money in the next five years, your retirement can last 30 or more years. As a result, you'll want to keep this money invested in long term growth vehicles such as property or the stock market.

3 - Risk Tolerance: It's important that you're able to sleep at night and not be overwhelmed with the up and down swings of the market. Would you consider yourself a conservative, moderate, or an aggressive investor? A financial game plan, accurate knowledge, and a diversified investment portfolio will help you to better cope with and understand risk.

4 - Diversification  A sure-fire way to minimize risk in your investment portfolio is to have your money spread around in various places.  People who lose their life savings in the stock market do so because they're heavily weighted in individual stocks. 

Employees of companies like Enron whose entire retirement portfolio went down the drain did so because they were heavily weighted in Enron stocks. If they would have held mutual funds with 100 or more companies in its portfolio and Enron was one of those companies, the losses derived from Enron would have been offset by the other 99 companies who remained stable and/or growing.

Invest in a diverse classes of investments.  Financial advisors never recommend you keep your money all tied up in one place.  There are ways to diversify your holdings even within the different classes of investments.  If you have elected to put a majority of your capital into real estate investments, you should always be aware of opportunities to invest in different types of properties. (REITs, multi-family, single family, etc.)

5 - Asset Allocation: The biggest decision you'll make that impacts your return on investment is not which property you select. Instead, it's how your investment is allocated between property, stock, bonds, and cash equivalents. 

Stocks are riskier than bonds. Stocks have also been more rewarding than bonds over an extended period of time. According to Ibbotson, an independent research firm, stocks have an average rate of return of 12% over the past 75 years whereas bonds has an average rate of return of 6% over the same time span. 

Real Estate has show an average of a 9% gain over the past 75 years, but there are many other factors that give real estate an advantage.  Real estate has indirect advantages of ownership in regards to tax savings and the ability to leverage the asset.  Leverage via real estate is much more commonplace as homeowners strive and stretch to buy their homes with what they can afford. Doing so has made fortunes for countless households across the nation.

Cash equivalents averaged right around 3%. The more your portfolio is weighted toward cash equivalents, the lower your rate of return will be.

6 - Track Record: Before selecting an investment, you want to look at its track record. Take a mutual fund for example.  The longer the mutual fund has been in existence, the longer the track record you can obtain. At a minimum, you want to purchase mutual funds that have a five-year track record or better. A track record will give you a history of how well the mutual fund performed over the years. 

For real estate investing, it is import to gather as much data on the local market as possible.  This is where it helps to have some type of support system or partnership with a larger entity.  There are services and groups that you can belong to that will help you with the task of analyzing the local market.  We’ll talk more about the pros and cons of different types of groups in later chapters.

7 - Dollar Cost Averaging:  Dollar cost averaging sounds more complicated than it is.  It simply refers to investing consistently over time.  You will do better investing in the long run if each month and each year you have a determined amount that you plan to invest.  

As opposed to trying to time the market or investing a large lump sum, it's better to systematically invest money at regular time intervals over an extended period of time regardless of the fluctuation of the market. This allows you to buy more when prices are down and allows you to buy less when prices are high. 

The huge opportunity for investing right now due to the economic recession may have been what sparked your interest in the real estate market.  Prices of properties are uncharacteristically low, and certain to rebound.  This is a unique situation we are in right now.  Typically, there will be some fluctuation in price in any market, but we find ourselves now in extraordinary circumstances and poised for great returns.