CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Building your own investment strategy

Lesson 3 of 4

The importance of planning ahead

At this stage, you should have a clearer picture of how you’ll manage your investment process. You know why you’re investing, how much money and time you can commit, as well as how much growth you want to achieve and in what timeframe.

Now you’ll need to introduce a little reality check. There are risks involved with investing. You need to think carefully about everything that could derail your wealth-building and develop a plan for how you’ll deal with these situations should they arise.

Below are a few tips that will help you plan for almost any future risk.

Check the average returns of the market you plan to invest in

If you’ve never invested before, it’s impossible to guess how much you can expect to profit from a particular asset. Your strategy should therefore include the market’s average annual returns. Remember, this is just to give you an idea of past performance, but there’s no guarantee that these results will continue after you put your money up.

Knowing how much you can expect to gain each year will be useful in choosing investments that could help you reach your goal. It can also help you adjust your strategy if needed, since you’ll be able to see if your goal is attainable in your preferred timeframe.

Let’s say you need your capital to grow by 10% per year for the next ten years to reach your goal. You consider investing in a FTSE 100-tracking ETF, so you look at how the index has performed over the last decade. If you found that the FTSE 100 only returned 5% per year in that period, you may need to adjust your strategy to reach your goal.

Question

You can adjust your strategy by (select all that apply):
  • a Investing in a market with higher returns
  • b Increasing your monthly contribution
  • c Extending your goal date
  • d All of the above

Correct

Incorrect

All these responses are appropriate. You might also consider adjusting your growth goal to an amount that’s more attainable given your findings.
Reveal answer

Choosing an investment with higher returns sounds like the most logical decision to make, so why isn’t it the only answer in the exercise above? Well, because an asset or market that yields more returns may also be one that’s prone to higher levels of volatility and thus risk.

Remember, investing is a long-term endeavour, so making quick money shouldn’t be your goal here. Assets with a better track record of consistent returns should ideally make up the majority of your portfolio.

Consider how much you might lose

The main risk of investing is that the value of your investment could fall at a time when you need to access your cash. While it’s impossible to know how much you could lose on an investment, you can get a sense of this by looking at its history.

However, sometimes unprecedented events can cause a market that normally does well to experience a downturn, regardless of its past performance. For example, the FTSE 100 had hit a series of record highs before the spread of the novel coronavirus in 2019/2020.

When the pandemic hit globally, it brought about a huge drop in the index’s performance as lockdowns limited trade across many of its constituents. Towards the end of March 2020, the index had dropped by close to 34% from its pre-pandemic peak.

The FTSE 100 later recovered these losses. But had you invested in a FTSE 100-tracking ETF and sold your position before this, you would’ve made a significant loss.

Know the right action to take

Watching your investment drop in value could tempt you to sell your stake prematurely. It’s only by studying an asset’s patterns in the market that you can understand important details about its performance.

For instance, you might find that Apple’s share price rises around the time a new iPhone model is about to launch. After this, the stock may drop as investors and traders sell their holdings to reap the profits of this temporary rise in value.

Had you not known this, this downturn may have scared you into selling your shares to avoid losing your funds. However, given Apple’s growth history, selling too soon wouldn’t come only at the price of the transaction, but also at an opportunity cost.

Did you know?

An opportunity cost is the loss that you make by missing out on an occasion to benefit from something. In this context, the opportunity cost from selling your Apple stock during a temporary downturn would mean you lose out on future profits as well as any dividends you could’ve received had you held onto your investment longer.

The earlier scenario on the FTSE 100’s 2020 decline is also a great example of why it’s important to do your research before making any decisions about your investments.

To an inexperienced market participant, the index’s downturn would’ve been a signal to jump ship. Considering that the FTSE 100 later recovered to above pre-pandemic levels, abandoning your investment could’ve meant you lost out on the growth that followed.

Just like a sale in a store, falling share prices may present an opportunity to buy. So instead of selling assets that could recover in the future, you can instead increase your holdings with the hope that the market will bounce back.

When you look at an asset’s history, consider factors like how much its value fell before it recovered in the past as well as the timeframe in which this occurred. Having those details close at hand when the markets drop will help you hold steady when the price drops again because you’ll understand that falling share prices are a normal part of investing. However, financial markets are volatile, so there’s no guarantee that a particular asset will return to previous levels

Lesson summary

  • Your investment strategy should take into account any risks you might encounter now and in the future
  • Look at how a market has performed in the past to get an indication of how it may perform in the future
  • The markets change direction often, but research will help you understand when it’s the right time to sell and when to hold your assets
Lesson complete