What type of investor are you?

do-it-yourself-investors-toolkit

Before you start investing you need to think about your goals, how long you are planning to invest and how much risk you can stomach.

What is it that you hoping to achieve? Answering these questions will help you pick the most suitable investments for you.

The other question to ask yourself is how long are you willing to invest for? Ideally, you should be able to leave your money invested for at least five years.

If you have less than five years in mind before you intend to spend your money, then you should stick with cash, even though interest rates are currently at historically low levels.

This is because if you invest in the stock market and it falls in value, you will have very little time to claw back any losses.

Before investing you should make sure that you have paid off any expensive debt and have enough money in cash to cater for any short-term emergencies.

This will stop you going into debt or cashing your investments in at the wrong time if you need to get hold of some money urgently.

Three tests to pass before making your first investment

Next, you need to decide how much risk you are prepared to take. Your age is a factor in this. Those who are younger have much more time to ride out stock market volatility than those who are about to retire.

But your investment goals are important, too. For instance, someone in their 20s or 30s who saving is saving for their pension has a different risk mindset compared to if they were saving towards a house deposit.

THREE INVESTOR TYPES

We look at three different types of investors: the low-risk investor, medium-risk investor and high-risk investor.

Regardless of your risk appetite, you should look to invest tax efficiently and for most people this will mean utilising Isa and pension wrappers.

A beginner's guide to Isas

The high-risk investor

High-risk investors are willing to risk substantial amounts of their investment for the possibility to get much higher returns.

First-time investors should usually avoid higher-risk or more specialist investments, unless they fully understand the risks and are prepared to take a long-term perspective, say 10 years or more.

Actively managed funds that invest in a specialist area, such as biotech, offer potentially high returns, but the trade-off is that investors will receive a bumpy ride. Those who buy at the wrong time could be left nursing big losses.

Patrick Connolly, certified financial planner at Chase de Vere, says investing in emerging markets has the potential to reward patient investors.

Click here to view Foxtrot: our long-term growth Model Portfolio for higher-risk investors

The medium-risk investor

Medium-risk investors are willing to risk more of their capital in order to get higher returns.

You can reduce the risks of investing in individual shares of companies by investing in a wide range of shares through investment funds. This will be a sensible approach for most people.

For medium-risk investors, Connolly recommends a tracker fund which aims to replicate the performance of the FTSE All Share Index.

He says the advantages of investing in a tracker are lower charges, little likelihood of significant underperformance and no concerns about your fund managers leaving.

This last point is really important because with an actively managed fund you always face the risk that your fund manager or their investment team will leave, whereas a tracker fund can be a true buy-and–hold option.

Do trackers beat active funds?

This is ideal for a novice investor who won't face the dilemma of deciding whether one fund manager is likely to perform better than another, says Connolly.

Click here to view Charlie: our long-term growth Model Portfolio for medium-risk investors

The low-risk investor

Low-risk investors are uncomfortable about the idea of losing money, but want to secure returns that are higher than cash deposits.

If you're concerned about stock market risks you can reduce these further by investing in asset classes such as fixed interest and property alongside global funds that hold shares.

It is still sensible for most low-risk investors to have some exposure to shares, says Connolly.

This is particularly the case for novice investors investing regularly, as in the early years they'll have little invested and so won't suffer unduly if stock markets fall.

Also, if investors are taking a long-term perspective, which they should be, it is difficult to generate decent returns without having some money in shares.

AND FINALLY...

Once you've explored your risk appetite, make sure you don't get swayed by investments just because they are at the top of the performance tables.

Strong recent performance should be seen as a warning sign rather than as an opportunity to buy, as investment gains have already been made and so you risk jumping in at the top of the market.

Connolly recommends that you review your investments every six months to make sure you that they are performing in line with your expectations.

If your investments aren't performing as you expected then try and understand why before making any changes.


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