Investing in stock market: Have you taken the correct path?

While money doesn’t grow on trees, it can grow when you save and invest wisely in the stock market. Knowing how to secure your financial well-being is one of the most important things you’ll ever need in life.

No matter how much or little money you have, the important thing is to educate yourself about your opportunities. In this article, you will be guided through the correct path of investing in the stock market.

Define your goals

Knowing how to secure your financial well-being is one of the most important things you can do for yourself. You don’t have to be a genius to do it. You just need to know a few basics, form a plan, and be ready to stick to it.

To end up where you want to be, you need a financial plan. Ask yourself what you want. List your most important goals first. Decide how many years you have to meet each specific goal, because when you save or invest, you’ll need to find an option that fits your time frame.

Figure out your finances

Take an honest look at your entire financial situation - what you own and what you owe. This is a ‘net worth statement’. On one side, list what you own. These are your ‘assets’. On the other side, list what you owe. These are your ‘liabilities’ or debts. Subtract your liabilities from your assets. If your assets are larger than your liabilities, you have a ‘positive’ net worth. If your liabilities are larger than your assets, you have a ‘negative’ net worth.

You’ll want to update your ‘net worth statement’ every year to keep track of how you are doing. Don’t be discouraged if you have a negative net worth - following a financial plan will help you turn it into positive net worth.

The next step is to keep track of your income and expenses. Write down what you and others in your family earn and spend each month, and include a category for savings and investing. If you are spending all your income, and never have money to save or invest, start by cutting back on expenses. When you watch where you spend your money, you will be surprised how small everyday expenses can add up. Many people get into the habit of saving and investing by paying themselves first. An easy way to do this is to have your bank automatically deposit money from your paycheck into a savings or investment account.

Save for a rainy day

Savings are usually put into safe places that allow you access to your money at any time. Examples include savings accounts, checking accounts, and certificates of deposit.

Most smart investors put enough money in savings to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.

But how ‘safe’ is a savings account if the interest it earns doesn’t keep up with inflation? That is why many people put some of their money in savings, but look to investing so they can earn more over longer periods of time.

Understand what it means to invest

When investing, you have a greater chance of losing your money than when you save. Unlike fixed deposits, the money you invest in stocks doesn’t generate fixed return.

You may reduce the ‘principal’, which is the amount you’ve invested. But when you invest, you also have the opportunity to earn more money. On the other hand, investing involves taking on some degree of risk.

Diversify your investments

Diversification can be neatly summed up as, ‘Don’t put all your eggs in one basket’. The idea is that if one investment loses money, the other investments will make up for those losses. Diversification can’t guarantee that your investments won’t suffer if the market drops. But it can improve the chances that you won’t lose money or that if you do, it won’t be as much as if you weren’t diversified.

Gauge your risk tolerance

What are the best saving and investment products for you? The answer depends on when you will need the money, your goals, and whether you will be able to sleep at night if you purchase a risky investment (one where you could lose your principal).

For instance, if you are saving for retirement, and you have 35 years before you retire, you may want to consider riskier investment products, knowing that if you stick to only the ‘savings’ products or to less risky investment products, your money will grow too slowly. Or, given inflation and taxes, you may lose the purchasing power of your money. A frequent mistake people make is putting money they will not need for a very long time in investments that pay a low amount of interest.

On the other hand, if you are saving for a short-term goal, five years or less, you don’t want to choose risky investments, because when it’s time to sell, you may have to take a loss.

What you can do to avoid investment fraud

Ask questions. Fraudsters are counting on you not to investigate before you invest. Fend them off by doing your own digging. It’s not enough to ask for more information or for references - fraudsters have no incentive to set you straight. Take the time to do your own independent research.

Research before you invest in the market. Unsolicited emails, message board postings, and company news releases should never be used as the sole basis for your investment decisions. Understand a company’s business and its products or services before investing.

Know your registered investment adviser. Spend some time checking out the person touting the investment before you invest - even if you already know the person socially. Assess the individual. You can obtain a list of registered investment advisors in Sri Lanka by accessing the website of the Securities and Exchange Commission of Sri Lanka (www. sec.gov.lk ).

Be wary of unsolicited offers. Be especially careful if you receive an unsolicited pitch to invest in a company, or see it praised online, but can’t find current financial information about it from independent sources. It could be a ‘pump and dump’ scheme. Be wary if someone recommends foreign or ‘off-shore’ investments. If something goes wrong, it’s harder to find out what happened and to locate money sent abroad.

Protect yourself online. Online and social marketing sites offer a wealth of opportunity for fraudsters.

Know what to look for. Make yourself knowledgeable about different types of fraud and red flags that may signal investment fraud.

Red flags for fraud and common persuasion tactics

How do successful, financially intelligent people fall prey to investment fraud? Researchers have found that investment fraudsters hit their targets with an array of persuasion techniques that are tailored to the victim’s psychological profile. Here are red flags to look for:

If it sounds too good to be true, it is. Watch for ‘phantom riches’. Compare promised yields with current returns on well-know stock indexes. Any investment opportunity that claims you’ll receive substantially more could be highly risky - and that means you might lose money. Be careful of claims that an investment will make ‘incredible gains’, is a ‘breakout stock pick’ or has ‘huge upside and almost no risk!’ Claims like these are hallmarks of extreme risk or outright fraud.

‘Guaranteed returns’ aren’t. Every investment carries some degree of risk, which is reflected in the rate of return you can expect to receive. If your money is perfectly safe, you’ll most likely get a low return. High returns entail high risks, possibly including a total loss on the investments. Most fraudsters spend a lot of time trying to convince investors that extremely high returns are ‘guaranteed’ or ‘can’t miss’. They try to plant an image in your head of what your life will be like when you are rich. Don’t believe it.

Beware of the ‘halo’ effect. Investors can be blinded by a ‘halo’ effect when a con artist comes across as likeable or trustworthy. Credibility can be faked. Check out actual qualifications.

‘Everyone is buying it’. Watch out for pitches that stress how ‘everyone is investing in this, so you should, too’. Think about whether you are interested in the product. If a sales presentation focuses on how many others have bought the product, this could be a red flag.

Pressure to send money ‘right now’. Scam artists often tell their victims that this is an once-in-a-lifetime offer and it will be gone tomorrow. But resist the pressure to invest quickly and take the time you need to investigate before sending money.

Reciprocity. Fraudsters often try to lure investors through free investment seminars, figuring if they do a small favor for you, such as supplying a free lunch, you will do a big favor for them and invest in their product. There is never a reason to make a quick decision on an investment. If you attend a free lunch, take the material home and research both the investment and the individual selling it before you invest. Always make sure the product is right for you and that you understand what you are buying and all the associated fees.

Monitor your investment

Investing makes it possible for your money to work for you. In a sense, your money has become your employee, and that makes you the boss. You’ll want to keep a close watch on how your employee, your money, is doing.

Some people like to look at the stock quotations every day to see how their investments have done. That’s is alright but make sure you don’t get too caught up in the ups and downs of the ‘trading’ value of your investment, and sell when its value goes down temporarily - even though the performance of the company is still stellar. Remember, you’re in for the long haul. Some people prefer to see how they’re doing once a year. That’s probably not often enough. What’s best for you will most likely be somewhere in between, based on your goals and your investments. But it’s not enough to simply check an investment’s performance. You should compare that performance against an index of similar investments over the same period of time to see if you are getting the proper returns for the amount of risk that you are assuming.

While you should monitor performance regularly, you should pay close attention every time you send your money somewhere else to work. Every time you buy or sell an investment you will receive a confirmation slip from your broker.

Make sure each trade was completed according to your instructions. Make sure the buying or selling price was what your broker quoted, and make sure the commissions or fees are what your broker said they would be. Watch out for unauthorised trades in your account. If you get a confirmation slip for a transaction that you didn’t approve beforehand, call your broker. It may have been a mistake. If your broker refuses to correct it, put your complaint in writing and send it to the firm’s compliance officer. Complaints should be made in writing. Remember, too, that if you rely on your investment professional for advice, he or she has an obligation to recommend investments that match your investment goals and tolerance for risk. Your investment professional should not be recommending trades simply to generate commissions. That’s called ‘churning’, and it’s illegal.

The article only covered the basics, and there’s a lot more to learn about investing in stocks. But you’ll be learning as you go and over your lifetime. As said, the most important thing is to get started. Remember to ask questions as you make your investment decisions.