List Your Financial Objectives. DEVELOP YOUR FINANCIAL PLAN
The investment process begins with a financial plan that lists your
financial objectives and the road map to achieving those objectives.
If you don’t know where you are heading, you won’t know how to
get there.
The first step in any investment plan is to determine what you want
to achieve from your investments and when you want this money
to be available. You probably have many objectives, namely, saving
for retirement in 20 years, paying for your children’s education in
10 years, and making a down payment on a vacation house in
2 years. Financial objectives are the financial milestones that you
would like to achieve through investing. Take a few moments to list
your financial objectives and determine how much you want to
achieve with each objective in the future. Possible objectives include:
* Funding an emergency fund within one year
* Funding the purchase of a car in five years
* Funding a child’s college education in 10 years
* Building a retirement fund over the next 25 years
Investing for retirement is not the same as investing for shorterterm
objectives owing to the time horizon and risk factor.
Time Horizon
Listing the time horizon is important because it gives you a better
idea of how much you will need to fund each objective. The amount
of money that you have to fund each objective is directly related to
your financial condition or net worth. Table 1–2 illustrates how you
can determine your net worth. Net worth is the difference between
what you own and what you owe.
Reviewing your monthly budget also may assist you in determining
how much you have to invest and the level of risk that you
can accept.
Table 1-2
What Are You Worth?
| List What You Own (Assets) |
Minus |
List What You Own (Liabilities) |
Risk
Evaluate your objectives with regard to risk, which may be characterized
as follows:
* Safety of principal
* Stream of income
* Capital growth
Safety of Principal Money market securities, such as
bank accounts, savings accounts, CDs, money market mutual
funds, Treasury bills, and commercial paper, offer safety of principal
and low rates of return. Short-term objectives such as building
an emergency fund and saving for short-term purchases within
the year fall into this category of investments. Returns from these
securities often do not cover inflation and taxes.
Stream of Income Investments that provide a steady
stream of income with higher rates of return than money market
securities include bonds and preferred stock. The tradeoff in seeking
higher levels of return from bonds and preferred stock is the
possible loss of principal. When bonds and preferred stock prices
decline below their acquisition costs, investors experience losses of
capital (principal loss) should they have to sell their investments.
High-risk, high-return bonds (junk bonds) offer the potential of
higher streams of income than investment-grade bonds, but junk
bonds are also more likely to default on the repayment of principal
to their bondholders. Investors looking to fund objectives with
one- to five-year time horizons use bonds with matching maturities
to their time horizons to earn higher rates of return than money
market securities.
Capital Growth Investing for capital growth has the potential
to provide an increase in value of the investments also referred
to as capital growth. Stocks offer the potential for capital growth
when stock prices increase above their acquisition prices. The risk is
that a stock’s price can decline below its acquisition cost, resulting
in a capital loss. For this reason, you need a longer time horizon
(greater than five years) in order to be able to wait out any losses in
the stock market. Some stocks pay dividends, thereby providing
stockholders with a stream of income. Generally, the yields on
dividend-paying stocks tend to be lower than the yields of bonds.
However, not all stocks pay dividends, and investors invest in these
stocks for their potential capital growth. Stock investments are suitable
to fund investors’ longer-term objectives (with a time horizon
of greater than five years), such as building a retirement fund.
In summary, there is a tradeoff between risk and return. Lowrisk
investments (money market securities) guarantee principal but
provide low returns in the form of income. Fixed-income securities
(bonds and preferred stock) provide higher levels of income but
carry a risk of loss of principal in the event of default for bonds or
having to sell preferred stock at a lower price than the purchase
price. Common stocks offer the greatest total return (capital growth
and income) over long periods of time but carry a higher risk of
loss of principal over short periods of time. Your personal circumstances
(age, marital status, number of dependents, net worth, and
income) determine your tolerance for risk as a guide to your choice
of investments.
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Categories in Trading Mistakes
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Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor
Using too much Leverage
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Failure to control Risk
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Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader
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