Investing is a complicated subject. And one where many dangers lurk for the unwary and inexperienced investor. Nevertheless, if you follow the simple rules of our little investment basics, you are well-equipped to avoid the worst investment traps and invest your money successfully.
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| The Basics of Investing |
10 principles that you should always keep in mind when investing money:
1. Be clear about your goals
It sounds banal that you must be clear about your goals before investing. However, an intensive examination of one's goals is by no means a matter of course. However, it is essential for good planning and the right decision.
- Are you planning any major purchases in the medium or long term?
- Are you planning to move, or do you want to start a family?
- Is your professional situation uncertain, or are you about to retire?
- Will you have higher or lower monthly charges in the future?
- Are you financially stable, or is the overall situation uncertain and the future difficult to predict?
- Would you like to make a one-off investment, or would you rather save something every month?
- Divide up your funds: do you want to invest part of it over the long term and still have it available if necessary?
Every investment must achieve these three goals at a time. You can only expect high returns by sacrificing availability or security.
All these are questions you should ask yourself because they provide information about which investment best suits your personal needs.
2. Paying off debt has priority over investing
Before investing, remember one thing: credit and loans are expensive. They generally cost more interest than you can earn with an investment of the same amount. This means you should always try to reduce debt before investing money elsewhere. Paying off credit and loans is often the best investment you can make.
There are exceptions to this rule, for example, when taxes reduce the net interest on the loan, which can be the case with rented properties. Some old home savings contracts offer up to 4 percent returns because of the bonus interest. And classic life insurance policies taken out before 2004 have tax advantages and, depending on the provider, the guaranteed returns after costs can reach around 2 or even 3 percent.
You can certainly hope for higher returns than the current low-interest rates on loans, especially with inexpensive investments in shares using ETFs. However, this is uncertain. In the past, there have been phases of 10 to 15 years that have yet to be notable returns on the stock market.
Anyone who is debt-free and has a sufficiently high reserve will also avoid over-drafting the current account in the future if damage to the household or car needs to be replaced or repaired. A call money account with a good interest rate at a bank with German deposit insurance is best suited for this.
3. Insurance can protect assets
Certain events can have serious financial implications. For example, the most solid financial investment can vanish into thin air in no time if you are liable for damage to your assets. Anyone with a family to provide for may want to avoid pushing them into financial difficulties if they die unexpectedly or can no longer work due to illness or an accident. Consider these risks. Many of them are well-secured in our welfare state, but not always to the extent that enables them to maintain their usual standard of living.
Those who do not want to jeopardize their standard of living through the occurrence of certain risks can buy appropriate insurance coverage. Only you know which risks you want to protect and which risk protection you feel more comfortable with. Also, think about how much insurance coverage you want. For example, do the surviving dependents have to be cared for until retirement or are five years enough because this period is sufficient to adjust to the new situation? Avoid the rules of thumb and checklists that salespeople like to use. Your personal needs are the only decisive factor.
4. Can and do you want to take risks?
The more risk you take, the higher the returns can be. So the risk is not bad per se. And security has its price, and the returns are then simply lower: with the current inflation figures, it is impossible to compensate for inflation with secure investments. So the purchasing power of your money is currently shrinking.
Since there are no safe investments that can guarantee inflation compensation, there is only one way out: deciding which risk is still acceptable for your needs. You have to be comfortable with investing. There must be no nasty surprises when the stock markets are erratic again. And you should still be able to sleep well. The number of possible losses should therefore be clear to you in advance, and you should be able to deal with them.
Our online return calculator lets you feel the return opportunities and risks of different investment allocations. The important thing here is that this only applies if you invest wisely in the shares—more on that in the next step.
Risk-bearing capacity is also important with a personal willingness to take risks. Because only some people who would like to have more returns can also afford a higher risk due to their life situation, anyone who has to make a living from the assets should generally avoid fluctuations in value unless the investments are so large that the changes are irrelevant.
5. Spread the risks
It doesn't matter whether you want to invest a larger sum of money as a one-time investment or just a small monthly savings contract: spread the risks! Capital markets always harbor risks, even if the newspapers paint a rosy future. Stock prices can always go down, and interest rates can turn anytime. But make sure to distinguish risk-spreading from simply buying multiple products. If you only have savings bonds, overnight money, and bank savings plans, you are not spreading the risks! Rather, the decisive factor is the asset class you represent with the product.
You can choose from the following:
- Participation in companies, in the form of shares or, even more widely spread, in the form of global equity index funds (ETFs).
- Debts, also often called monetary values. All loans fall into this category, including call money, savings bonds, government bonds, or pension funds. Classic life insurances also fall into this category, mainly buying government and bank debt instruments.
- Real estate, in the form of your own home, rented property, or open-ended real estate funds and real estate investment trusts (REITs), also offers access to this asset class for small amounts. Beware of closed real estate funds.
- Speculative assets such as commodities or precious metals. These investments do not pay interest, and their performance is highly uncertain. However, gold is the oldest payment known to humanity, and every paper currency (category: debt) has survived. For information on investing in gold, see this post.
The asset classes usually develop differently. For example, when stocks tend to weaken, bonds have often had the edge in the past - and vice versa. When the value of shares and debt collapsed worldwide during the financial crisis, the price of gold boomed. Similarly, during the corona pandemic, investment in gold stabilized the portfolio. If you spread your assets across these asset classes, you can rule out the risk of total loss and stabilize the overall return. Risk spreading is also called diversification.
If you no longer want to leave your investment to an advisor or salesperson but want to take it into your own hands, you can read about how to do this in this article.
6. Be skeptical of sellers
Bank advisors and other financial intermediaries are usually paid on a commission basis. So you are a seller. You must therefore assume that these consultants will only recommend products to you from which the salespeople make a decent living. Of course, this also applies to the savings bank consultant, even if he does not earn anything from the sale.
Savings banks and Volksbanks also sell their products or products from third parties with corresponding sales cooperation and set sales targets for their employees. What can you do about it? Nothing. While you can consult other competitors who are also sellers, and they may suggest other products, you need more time to make your decision.
Unfortunately, there is also no guarantee that you will receive better advice from the so-called fee-based consultants. These often sell ETF savings plans in an insurance cover and collect outrageous fees for this, as an example from the consulting practice of the Baden-Württemberg consumer center shows.
If you want to form your own opinion, you can rely on independent sources, for example, test reports from Stiftung Warentest and advice from consumer advice centers.
7. Be critical of past performance
It's a familiar situation: To sell you a product, you are presented with beautiful graphics with curves striving upwards. That's the development so far, you're told, that's a 1A paper with which you can only win.
Caution! No expert in the world can predict how security will develop. It has long been a well-documented truism among researchers that forecasts by experts and analysts are at least as often wrong as they are right.
If someone claims the opposite during the counseling session, then you should get up and leave immediately. Such forecasts are only used to sell products and to switch securities constantly. They have nothing to do with serious advice, which should always place value on an appropriate spread of risk.
8. Minimize costs and commissions
Costs and commissions reduce the return you can get from an investment. The charges are certain, and you always have to pay them, while interest income and positive price developments are often uncertain.
Depending on the investment product, there are different costs. You can find an overview of different product types in this article and our guide. Avoid unnecessarily high prices for financial products. Commissions, also known as donations, can generally be negotiated.
Incidentally, funds and other products still incur fees after they have been sold. The annual fees can be found in the so-called key investor information, also known as the basic information sheet or product information, under "Ongoing costs." Because of a sales follow-up commission that the fund company pays to the bank, your bank automatically continues to earn from you even after the sales pitch.
So take a close look and ask questions if you have any doubts. The cost burden is one of the most important criteria for evaluating investment products. Even the brightest past performance and the rosiest forecasts for the future shouldn't keep you from taking a sober look at costs. There are also cheap products without commissions.
9. Document what your investment advisor advises you to do
Most people need advice to take care of their assets. Many go to a bank or a so-called independent consultant, who can and must only sell products. Some also turn to fee-based consultants who pursue their interests or Robo-advisors who are paid by the customer and do not earn anything from product sales.
Whoever you turn to, the advice remains a matter of trust. Anyone who needs advice doesn't know better than the consultant and can, therefore, not judge whether the consultant is doing his job well. For example, a checklist you can use to inquire about qualifications will not help. If you want your trust, you should earn it.
Make that clear to your advisor. This assumes that your advisor is 100 percent behind what they told you in the interview.
10. Check your goals and strategies regularly
You have made your goals clear, obtained sufficient information, and made a well-founded investment decision. And now?
As a rule, it doesn't make sense to rebalance your investments every few months because that only incurs costs again. An old stock market adage rightly says: "Back and forth empties pockets."
Nevertheless, it would be best to deal with your finances regularly. Life situations can change, and unforeseen events can occur. After a while or after an inheritance, you may no longer focus on the return but, above all, on liquidity because your plans have changed, and you need to have the money quickly.
Conclusion
So, at least once a year, check: how are my finances doing? Has something fundamentally changed in my situation? Do my investments still meet my needs? Only if you keep an eye on all of this can you be sure that your investment will still meet your expectations in a few years.
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10 Principles That You Should Always Keep In Mind When Investing Money
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The Basics of Investing