Investing for Beginners

This Investing for Beginners article presents the key concepts and an overview of the investment process. It can provide you with a map and a starting point to your journey from beginner to competent investor.

Please read the disclaimer at the end of this article.

Before We Start

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You Should Build an Investing Plan

In plain terms, a successful investment plan is one that meets your objectives, but also it must be one that you can execute. After all, how good is the “best” investment plan if you cannot follow it?

This is an Investing for Beginners overview, so it is naturally not filled with advanced things. However, we cannot skip the necessary parts, even when it may look a bit more advanced than what some would call a beginners' plan.

Investing for Beginners - Investing Objectives

Let’s start with the investment objectives.

Return Objectives

Everybody would like to achieve the best possible investment return, but that is too open to be a goal. You need to specify in detail what you want.

Even stuff like “I want to beat the stock market” is not detailed enough. For instance, it does not specify the time horizon. It also does not specify which stock market index you meant.

Particularly, I like investment objectives that are relative to the inflation rate. For example, 2% or 3% per year above the consumer price index on average over every 5 or 10 years (rolling periods).

However, don’t forget that your desired return must be realistic.

Risk Objectives

People would prefer not to take any risk, but that is not possible. Even the safest investment involves some risk. Normally, you need to take higher risks if you want to produce higher returns.

I like risk objectives related to volatility. For example, to try to keep the portfolio volatility under 10% or 15%.

However, simple stuff also works. For example, some people are happy with a rule like "I do not want my portfolio to fall more than 20% from its previous peak."

As a warning, a common mistake is to "overestimate" the risk tolerance. In other words, people believe they can handle their portfolio's risk level when they can not.

You need to calibrate your portfolio to a risk level you are willing and able to accept. You also have to balance your return and risk objectives. They go hand in hand.

Now let’s take a look at the investment constraints.

Time Horizon

Are you investing for the long term? During a crisis, can you hold on to your portfolio?

Your answers to such questions will shape your risk and return objectives. Again, it is all related. They must fit together.

Tax Situation

While building your investment plan, you need to consider your tax situation. Your tax situation is very relevant because, in the end, what matters is your after-tax performance.

You should consult a tax expert to get personalized advice.

To illustrate, I want to mention a few possible cases. Different investment vehicles might follow different tax rules. Your capital gains tax rate may be different from your investment income tax rate. And so on.

On a more practical example, let's say inflation is 2% and your tax bracket is 20%. Your portfolio's return must be higher than 2.5% if you want to do better than inflation (after tax; using simple calculations).

Liquidity and Other Constraints

In general terms, the more liquidity you need, the less risk you can take. You also need to consider any legal restrictions and personal constraints.

Risk objectives and investment constraints are not something you find very often in an Investing for Beginners guide. However, they are very important and should not be ignored.

Investing for Beginners - Investment Strategies

Now that we have the objectives and constraints, we can start to put a strategy together.

Strategic Portfolio

Your strategic portfolio must meet your objectives and constraints. It must all fit together.

Normally, it is a passive portfolio.

In other words, you have to decide which assets (or asset classes) to add to your portfolio. You also need to decide how much (as a percentage of your portfolio) to invest in each of them.

Then, the asset selection remains fixed.

Your portfolio should be constructed to achieve your risk and return objectives, over your desired time horizon. It must also meet your other constraints.

Tactical Changes

Sometimes, short-term situations bring good investment opportunities. To be able to profit from them, you need some rules specifying how to proceed in such cases. That is your tactical strategy.

Your tactical changes are temporary deviations from your strategic portfolio.

In other words, your portfolio should be following your strategic allocation until some short-term situation brings a tactical opportunity. Then you change your portfolio aiming to profit from such opportunity. Once it is over, you change your portfolio back to your strategic allocation.

Note that you can only change your portfolio according to your own pre-defined tactical rules. There should be no spur-of-the-moment decisions here. 

We will talk more about strategies later.


How would you know if something is out of line if you are no looking?

Monitoring is an essential part of any investment plan. You have to track not only your performance but also your execution.

Performance tracking is about checking if your returns and risks are in line with your plan.

Execution monitoring is about two things. You should track if you are getting the best possible price every time you make a transaction. Moreover, it is also essential to check if you are following your plan.

Investment Policy Statement (IPS)

Investment Policy Statement is a fancy name, but the idea is simple: put it all together in a single document so you can refer back to it regularly.

You have made lots of decisions to get to this point. Are you going to remember everything in a few months? What about in a few years?

So, better get everything in writing, but don't forget it in some folder. Keep it at hand and review it from time to time.

This IPS can also help you in case you decide to hand over your investments to an investment adviser (or to a new adviser if you already use one). All your new adviser has to do is to follow your plan. It should be all there.

One last important thing, you should revisit your plan from time to time and, above all, if your unique situation changes.

I am sure an IPS does not feel like an Investing for Beginners' material... but it is essential. Please document everything. You will eventually need it.

Investing Strategies for Beginners 

There are too many investment strategies, but there is no need to list all here. Remember, the idea is to focus on strategies that you can realistically use.

“Any strategy that requires frequent monitoring and readiness to act is probably not feasible for most individual investors because it might conflict with their regular jobs and other responsibilities.”

Besides, frequent portfolio adjustments increase transaction costs and might overwhelm the benefits. 

I mentioned the strategic and tactical strategies before. Here I will get into more details.

Another very important point is that not only the strategy but the asset class selection must make sense to you. If it does not, then you will not be able to execute your strategy.

Strategic Asset Allocation

The strategic asset allocation is normally passive. In other words, you select your asset classes, decide how much you want to allocate to each asset class, and keep that allocation “fixed” over time. It is a great strategy in any Investing for Beginners playbook.

If you are risk-averse, you should have more safer assets’ than the riskier assets. For example, 80% safer assets and 20% riskier assets. Of course, you have to decide the exact percentages based on your objectives and constraints.

This is considered a passive strategy, but it is not really passive. If you simply build your portfolio and let it be, the percentages will deviate from your target over time.

A simple example. Let’s imagine a target allocation of 80% bonds and 20% stocks.

On moment 1, that is exactly the portfolio allocation. As time passes, bonds and stock prices will fluctuate, and the portfolio will deviate from the 80-20 target.

Let’s say that, sometime later, bonds are 78% and stocks are 22% of the portfolio.

The way to fix that is to rebalance the portfolio. In other words, one needs to sell 2% worth of stocks and buy bonds with the proceeds to bring the portfolio back to the 80-20 target.

Portfolio rebalancing is essential, but it can be expensive if you do it too often. I would say rebalancing once per semester or even once a year should be enough.

If your portfolio is volatile, then rebalancing every quarter might perform better. However, I would not rebalance more frequently than once every quarter. 

Tactical Asset Allocation

It is important to point out that tactical changes are optional.

In other words, if you build a good strategic portfolio and can withstand the losing phases, then you do not need to make any tactical changes.

However, a tactical strategy can be used to enhance performance and to reduce risk.

One simple example is to stay invested only if the portfolio’s assets are rising in price. There are several ways to measure an asset's trend, but the simplest is to use a moving average.

Let’s say 10% of a strategic portfolio allocation consists of stocks. When stocks are trending up, one stays invested. However, when stocks are trending down, once sell the stocks and hold cash instead.

Another example is to use a value factor. One would increase the stocks allocation when stocks are undervalued and wait until the stocks reach a fair value (or an overvalued level) to change the stocks allocation back to the strategic level.

Other strategies can be even more sophisticated, but they do not need to be. Sometimes, simple strategies are way more robust.

The bottom line is: tactical strategy is a bunch of rules that guide how and when to deviate from the strategic portfolio. The rules should also guide the portfolio back to the strategic allocation.

You also have to consider how much time is required to implement a tactical strategy. The strategy itself might be profitable, but it might require too much of your time. You need to balance out the pros and cons.

Once you have a strategy that makes sense to you, put it into the IPS and use the IPS as an execution and monitoring guide.

Taking Action

This part is very important. After all, how good is a plan that you do not use?

Let’s go step by step.

Step 1

Determine your objectives and constraints. Without knowing them, you cannot make any plan.

Step 2

Figure out if your objectives and constraints are realistic. If not, go back to step 1.

Step 3

Determine if there is a combination of asset classes that meet your criteria (step 1).

If it exists, then it is going to be your strategic asset allocation strategy. If you cannot find this combination, then it means you do not have a strategic allocation strategy that can meet your criteria by itself.

Step 4

You also need to decide if you want to employ a tactical asset allocation strategy.

Now you have four options.

Option A

You have a strategic allocation strategy and do not want to use a tactical strategy.

In this case, you can use your strategic allocation strategy alone.

Continue to step 5.

Option B

You have a strategic allocation strategy, but you also want to use a tactical strategy.

In this case, you need to find a tactical strategy to supplement your strategic strategy. Remember that you still need to meet your criteria.

In case you cannot find it, go back to step 1. Otherwise, continue to step 5.

Option C

You do not have a strategic allocation strategy, but you want to use a tactical strategy.

In this case, you need to find a tactical strategy to enhance your strategic strategy. Remember that you need to meet your criteria.

In case you cannot find it, go back to step 1. Otherwise, continue to step 5.

Option D

You do not have a strategic allocation strategy, and you do not want to use a tactical strategy.

Well, you have to go back to step 1 in this case.

Step 5

You need to decide if you will do it yourself, or if you will delegate it to a financial advisor.

If you want to delegate to an advisor, you need to decide which advisor (and if it is a human advisor or a robo-advisor).

Consider quality, reputation, and costs when evaluating the advisors. You want an advisor that has your best interests at the top of his or her list.

Step 6

Now you need to open the account(s) to execute your plan (with a brokerage company or other financial intermediary).

You must select a company you trust. There is always some risk, but you have to try to minimize it by making a good choice here.

Step 7

Create your IPS. Document everything there.

Step 8

Well, now it is time to put your plan in motion.

Step 9

This is also an ongoing step. You need to keep monitoring your execution and your performance on an ongoing basis.

That's it for now. Thank you for taking the time to read this long guide. I hope you liked it.


You could get our Free Financial Education Email Series... an extension of this Investing for Beginners guide. You would learn why and when to use the Investing Building Blocks. 

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We do not provide financial advice, and nothing in this investing for beginners guide should be construed as advice. The contents of this guide are presented ‘as is’ and on an educational and informational basis only. You are advised to consult your financial adviser before using, in any way, the information presented here. To the maximum extent permitted by applicable law, we disclaim all liability in relation to this guide and the contents of this guide.

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