Remember to keep a cash buffer
To start investing, one must be in a good place financially and this means having a cash buffer to cover unexpected expenses. Typically, that is three to six months’ expenses. Having some money at the bank makes you feel more comfortable and allows you to be flexible.
The three pillars of successful investing are: diversification, (preferably) a long-term time horizon and low cost. When it comes to investing, long-term is not six months, but more like 10+ years. Successful investment is possible with a shorter time horizon, but the longer the time horizon, the longer the compounding period and the higher the chance of success. Diversification is key
Diversification means holding more than one security, across different sectors (technology, healthcare, financials etc.) and also across asset classes (stocks, bonds, real estate etc.). Instant diversification can be found by investing in ETFs or mutual funds, which are baskets of securities managed by investment professionals. ETFs replicate an index and have lower costs than mutual funds. They are known as passive investments. Mutual funds, on the other hand, do not attempt to replicate an index, they usually have less holdings than ETFs and are known as active investments. And if you want optimal diversification, you can choose an ETF that tracks a global stock index; this way, you invest in stocks across all regions and across all sectors. The strategy
This phase is about how to do it. At this point, you should have an idea of how much money you want to invest and what you want to invest in. The question is, should you invest the entire amount at once or go for a staggered approach? The latter, also known as dollar-cost-averaging (DCA), is recommended.
The idea with DCA is to, instead of investing an amount all at once, spread it over a period of time, regardless of the ups and downs in the market. Divide the amount available into 10 equal parts, or whatever you feel comfortable with. If you have €100,000 to invest, you could make a €10,000 investment every month for 10 months or a €20,000 investment every two months. DCA is somewhat rule-based and has several advantages including:
Taking emotions out of investing by avoiding timing the market
Limit losses if the market declines
Invest regularly at a specific frequency
Spreading your investments doesn’t mean that you can’t take advantage of opportunities that present themselves and must wait a month or whatever timeline you’ve given yourself. If prices go down significantly, for example by 10% compared to your last purchase, you can choose to place a buy order now at a 10% lower price, which means that, for the same amount of money, you can buy more securities. Potential downsides of DCA
If, instead of going down, prices go up, your subsequent purchases will be at a higher price, and you will end up with less securities for the same amount of money. DCA in an up market means that you end up missing out on the potential gain you would have made if you had invested the full amount all at once. In addition, with DCA, the commissions paid per transactions are higher. What you get
With DCA, you take emotions out of the equation, and you do not attempt to time the market. You invest at a specific frequency but are open to investing earlier in certain circumstances, such as a significant price drop.