"Before starting long-term investing, what should I buy?" This is a question I have often received from many students.
In fact, The most challenging aspect of long-term investing is not how to start correctly, but how to complete the process of long-term investment properly. Therefore, the priority is not what to buy, but to understand the process of long-term investment, to understand oneself, and to make proper asset allocation, to complete one's journey of long-term investment.
This article shares three key considerations for long-term investing, including understanding the market, understanding oneself, and understanding the tools and methods, to evaluate the long-term investment approach that suits you best.
The First Key Consideration: Understanding the Market
1. Understand the important basic asset types in the financial market and choose assets with long-term upward trends.
Important asset categories in the financial market include stocks, bonds, gold, REITs, commodities, raw materials, etc.
However, not every asset is suitable for long-term investment. Priority should be given to assets with a long-term upward trend.
For most investors, the most basic and important assets are stocks and bonds.
Stocks: Stocks represent ownership in a company. Companies operate to provide products and services and generate profits, and stock investors share in these earnings.
Bonds: Bonds are certificates of debt. By lending money to governments or companies through bonds, investors can receive interest and reclaim the principal upon maturity.
Because stocks can continuously create earnings, and bonds consistently issue interest, stocks, and bonds as a whole tend to show a long-term upward trend over longer periods.
Conversely, assets like commodities and raw materials often have greater volatility than the stock market. They do not generate earnings or interest and lack upward growth characteristics, making them less suitable for long-term investment and more often used for short-term or swing trading.
2. Different assets have different investment returns and risk characteristics.
Although companies create earnings and bonds pay interest, this does not mean that stocks and bonds only rise and never fall. The reason is that at any point in time, the price people are willing to pay for an asset is influenced by their judgment of the future and current market sentiment, causing fluctuations. The degree of fluctuation varies among different assets.
Bonds are more influenced by the current interest rate environment, so it's not just historical returns that matter but rather recent years' returns that are more relevant. Unlike the stock market, the bond market, except for long-term bonds and high-yield bonds which have greater volatility, experiences less drastic changes in the short term with medium and short-term government bonds and investment-grade bonds. Although overall returns are lower than the stock market, stability is relatively higher.
Statistically, even in a 40-year long-term investment in U.S. large-cap stocks, there may be downturns of up to -50%. The scale of drawdowns in the bond market, on average, is smaller than that in the stock market.
The need to withstand price volatility is a crucial characteristic of the financial market and something that long-term investors need to understand.
Before embarking on long-term investments, investors should comprehend the risk characteristics of the assets they invest in, assess the risks they might encounter throughout their investment, and know which tools are suitable for them.
The Second Key Consideration: Understanding Oneself
After understanding the various assets in the market and their risk-return profiles, the choice of which markets to invest in should be based on your own conditions and risk tolerance.
1. Understanding One's Investment Goals
Goals such as accumulating retirement funds, saving for future college tuition for children, or a down payment for a house, may require selling and withdrawing funds at certain future points, or they may be under pressure not to incur significant losses.
The most common mistake in setting investment goals is the pursuit of high returns, with the belief that the higher the return, the better.
In investing, the potential for high returns is accompanied by high risks, which could also result in low returns or losses. Understanding one's goals and how much risk one can tolerate is crucial in determining the right long-term investment asset allocation that suits you.
2. How Long Can Invest?
A principle of investing is to only use surplus money, as the investment plan needs to be halted when the funds are required for other purposes.
The shorter the investment period, the lower the risk of the investment should be chosen. The longer the investment period, the more feasible it is to choose higher-risk investments.
Generally, if the investment horizon is less than 5 years, it's not advisable to choose high-risk investments. Although bearing lower risk might result in lower returns, the potential loss will also be smaller if the outcome is not as expected.
Conversely, if the investment period is longer, such as over 15 years, and you are willing to take on higher risk, you can choose higher-risk investments. Over a longer period, there's a higher likelihood of achieving returns close to historical averages.
3. How Much Risk Volatility Can Tolerate?
Everyone's ability to tolerate risk varies due to personal cash flow, age, and personality.
In investing, higher-risk asset classes include stocks, which historically, in some of the worst periods, have dropped by as much as -50%. For example, an investment of $1 million could drop to $500,000, or $20 million to $10 million. Although it might rise again later, the reality is that many people cannot endure such a process.
Once the price volatility exceeds your tolerance, it often means the end of your investment plan, rendering any long-term investment strategy meaningless.
Therefore, it's important to understand your risk tolerance and control the risk within your capacity when investing.
4. How Much Time Do I Have to Research Investments?
Investors with ample time to research can employ completely different methods compared to those without time.
Those who have the time and ability to research might adopt active investment strategies; if you lack the time for research, you might consider passive or index investing, or entrusting a fund manager with the operation.
The Third Key Consideration: Understanding Investment Tools and Methods
1. Decide on Asset Allocation Proportions
Asset allocation is a method of controlling investment risk by distributing funds proportionally across different assets.
The goal of asset allocation is to reduce overall asset risk and increase investment certainty through the low or sometimes negative correlation between different assets. The allocation method varies depending on the investment period and risk tolerance.
For example, stocks are more volatile, while bonds are less so. Therefore, a combination of these two types of assets can be used, such as a typical proportion of 60% stocks and 40% bonds. Compared to investing solely in the stock market, this might result in slightly lower long-term returns, but the volatility will be much reduced, and the potential drawdown in any single year may also be smaller.
2. Decide on Investment Targets: Beginners Should Use Broadly Diversified Investment Tools
There are many diverse investment tools in the financial field, such as stocks, bonds, mutual funds, ETFs, etc.
It's recommended for beginners to start with diversified fund tools, including mutual funds and index funds. Even with a small amount of capital, it's possible to achieve broad diversification, avoiding severe losses due to misjudgment in a single stock or bond.
3. Choose Investment Methods
There are many ways to decide on the timing of purchases for long-term investment, but the most challenging aspect for beginners is disciplined adherence to the plan.
For beginners, the simplest method is regular fixed-amount investing.
As long as the chosen assets have a long-term upward trend, regular fixed-amount investing can average out the purchase price over time. Though it may not always buy at the lowest price, it also avoids buying at the highest, helping investors to invest with discipline.
Start Long-Term Investing with Simple Execution and Diversification of Risk!
The most challenging part of long-term investing is not how to select targets, but how to execute a long-term investment plan with discipline.
Before embarking on long-term investing, it is crucial to fully understand the market, especially stocks and bonds, and their long-term characteristics and risks, so you can anticipate the fluctuations that might occur during the investment process.
It is also essential to have a good understanding of yourself before long-term investing, including your investment horizon and risk tolerance, to avoid making decisions that exceed your risk-bearing capacity in pursuit of returns.
After understanding the market and yourself, choose the appropriate asset allocation tools and decide the investment proportion for assets like stocks and bonds. It is recommended for beginners to start with tools that offer broad diversification and regular fixed-amount investing. Many fund tools currently provide the effects of diversified investment and regular fixed-amount investing.
After accumulating some investment experience, if you have your own opinions, you can allocate a portion of your funds to supplement and strengthen certain types of targets.