So in this blog, we are going to talk about the Importance of the Investment process. It’s very important for investors to go through a certain process to have success, many new investors have no plan, and they blindly throw money into an account or worse.
Many people choose not to save at all because they find the whole process of investing, saving for their retirement to be overwhelming. To understand this concept, we must know what investment is and why it is so important.
Why is the Investment Process Important?
Investment is a conscious act that involves the deployment of money in assets and securities by financial firms with a view to obtaining a target return in a specific period of time. Or to make it even simpler to understand we can say investing is like taking some resource and advancing it, there’s taking something important and increasing its value and with that kind of definition you’ll find out that investing is pretty common.
Investment is very important in today’s life. Inflation is the main reason why people need to invest, it causes the increase of consumer goods price in simple terms the value of money gets depreciated over time. Once a wise woman said, “Investment is important because if you cannot get your money to work for you, you will always keep working and will never get to retire.”
7 Important Steps of Investment Process
Investment process is all about planning where and when to invest. It is a set of guidelines that govern the behaviour of investors in a way that allows them to remain true to the principles of their investment strategy, which are the key principles that they hope to facilitate superior performance.
The investment process involves careful study and analysis of the various asset classes and the risk-return ratio attributed to them. Warren Buffet rightly said that never depend on a single source of income, make an investment to create a second source.
Before investing, you must know the process of investment. So we have broken the importance of the investment process.
Step 1: Meeting Investment Requirement
a) Adequate provides Necessities of life including funds for meeting adequate financial needs.
b) Adequate protection against various common risks (such as illness, disability, death)
Before you even start investing you need to meet certain investment prerequisites, that is you need to adequately provide for necessities of life that are emergency funds or emergency cash funds. You’ll often hear people and experts say that you should have six months set aside, six months’ worth of living expenses set aside for emergencies.
You might lose a job or your car might break down, you might have to fix that, you know the roof on your house might be leaking and you might need to fix that. There are all kinds of emergencies that pop up and you need to have an emergency reserve but certainly losing a job can be a big problem and it does happen.
You also need to have adequate protection against various common risks such as death, illness, and disability, so basically we’re talking about insurance like life insurance for death protection.
Now if you don’t have any dependents you don’t need life insurance but if you have a family if you have someone that is counting on you for the support you need life insurance and health insurance, no matter how healthy you are now you could get sick at any time and health insurance is a necessity.
Disability insurance another thing that people tend to forget, you may be in a profession where you know you can break a leg and can work but you can still become disabled and not able to work and for people who are in physical jobs you could be a plumber, you could be a carpenter you could be a truck driver if you become injured if you break a leg if you break an arm you may be out of work for quite a while in fact you’re far more likely to become disabled than you are to die so it’s important to have disability insurance so before you even start the investment process you need to look into these things.
Step 2: Establish Investment Goals
a) Accumulating retirement funds
b) Enhancing Income
c) Saving Major expenditure
d) Sheltering Income from Taxes
In order to establish our investment goals, we have to think about what it is we want to do? Are we trying to save money for retirement? Are we saving for a big Expenditure like buying a house or sending a child to college? Are we trying to shelter our income from taxes?
Okay, nobody likes taxes but some people are not in a high enough tax bracket to worry about that although all of us can try and shelter some of our income from taxes by investing in retirement accounts like an EPF or PPF that allows you to shelter some of that income from taxes you get a deduction today and you won’t pay the tax until you withdraw when you’re retired after you’ve established some goals.
For example, an engineering degree that costs around 12 lakh may cost around 25 lakhs in the next 20 years assuming that a child is on their own. Achieving these financial goals now requires different financial planning.
Suppose you wish to buy a house in the next five years that will require investment in a suitable investment plan for a period of five years so that when you wish to buy a dream house you have already accumulated the desired funds for your purchases.
Step 3: Adopting an Investment Plan
a) Always Develop a written investment plan
b) Try Specifying the target date and Risk Tolerance for each Goal
Let’s say that the market is down right now but you’re not going to stop investing in stocks. In fact, you might want to increase your investment in the stocks market because prices are low and you’re not going to be using that money for a long time so you want to have a plan.
It’s also a contract between you and your financial professional, if you’ve written an investment policy statement and your financial professional is investing in securities that don’t meet with your investment policy statement, perhaps you have a moderate level of risk and the person is investing in very high-risk technology stocks.
Well if they lose money for you then you may be able to have some course of action. It also helps the professional to do well for you because it’s hard to invest someone’s money when you don’t know what it is they want. So a clearly written investment policy statement is important.
Step 4: Evaluating Investment Vehicle
a) Assess potential return and risk
While evaluating the value of investment vehicles you will find different types of securities stocks bonds. Here the general category of stocks but there are a lot of different kinds of stocks, there are blue-chip stocks, those big companies that have been around a long time.
They’re very stable, they tend to generate a solid income, they tend to pay sufficient dividends, but they don’t tend to have a lot of growth because they’re very large companies than you have smaller companies.
Step 5: Selecting Suitable Investments
a) Research and gather Information on Particular Subject
b) Make investment Selections
Microsoft is probably a blue-chip company out it’s a very large well-established company but thirty years ago Microsoft was a small emerging company that had a lot of opportunities to grow, It’s harder for Microsoft or Reliance to grow now because it’s such a large company, the same with Apple, Samsung, Tata Motors, General Motors or General Electric or Ford.
These are big companies, they’re not going to grow that rapidly but there are some smaller and mid sized companies that have a lot more room for growth.
Once you’ve selected what you think are suitable investments you need to gather information and do some research on those investments so you have some general categories of risk and return what you might like to invest in. Then you start doing some analysis on these individual companies and then you make some investment selections.
Step 6: Constructing a Diversified Portfolio
a) Use Portfolio compromising of different Investments
This step is called Diversification, it can increase the returns or decrease the risks. Construct a diversified portfolio, so portfolio management is important. In personal finance when we talk about diversification we’re not just talking about buying a lot of stuff we’re talking about buying things that tend to have different attributes.
If you buy all technology stocks or if you bought all computer stocks when the computer industry is doing well your portfolio will do well, when the computer industry is doing poorly your portfolio will do poorly.
Never put all of your eggs in one basket. So you don’t want to just have a lot of different stocks, you want to have different kinds of stocks, you might want to have food companies, you might want to have some technology stocks, and you might want to have some transportation stocks, some financial stocks.
If you’ve watched the market at all, sometimes financial companies do very well, banks do extremely well and then there are times when they do extremely poorly, sometimes manufacturing companies are doing very well, sometimes they’re doing poorly, different kinds of companies do well in different types of environments. In order to be on the safe side, you must have a Diversified Portfolio.
Step 7: Portfolio Management
a) Compare Actual Behaviour with Expected Performance
b) Take Corrective Action when Needed
Food companies and companies that produce necessities tend to be much more stable, people have to eat even if the economy’s not that good but when it comes to technology or let’s say Airlines, airlines would be a good example if the economy is not good people don’t travel as much for the holiday they don’t travel as much on the business they get hurt but people still need to eat but you’d like to help hold companies like Airlines or hotels in your portfolio because when the economy is booming they tend to do very well.
Once you’ve set up that portfolio you need to do portfolio management, you need to see has it performed as well as it’s expected, have things changed? Do we need to take some sort of corrective action? Do we need to sell some of these securities and add other securities to the portfolio? There’s a process for going through this and the successful investor whether it’s an individual or whether it’s an investment professional, they will follow these basic steps in order to get the best possible outcome.
It doesn’t ensure that you’re always going to be right but when you have a plan and you stick to it and keep evaluating your plan you’ll do much better than the person who just essentially is like a gambler at a casino that just puts their money on red or black on roulette and just hopes the number comes up. If you have a plan and a strategy you’ll do much better.