5 guidelines for beginner investors

Clarifying what investments are and why you should invest is probably the first step you should take before taking action.

Investments are allocations of financial resources into specific assets, with the goal of investing - i.e., the process of acquiring and managing investments—being to grow capital and generate returns.

Investing over a prolonged period of time aims to achieve long-term financial stability and security. Through it, you not only strive to protect your savings from inflation, but also give them the chance to grow. This way, you accumulate funds for your future goals - be it for education, retirement, or other important life projects. Investing also brings additional financial independence, which can help you and your family feel more secure, confident, and prepared for expected and unexpected expenses.

Here are some important guidelines to prepare you for your investment start.

 

1.      Differentiate between saving and investing

Saving and investing are two distinct, interconnected, and consistent approaches to managing personal finances. Before pointing out the differences, let us consider what they have in common. In both approaches, you set aside a portion of your income - you refrain from consuming now, i.e., from current consumption, and instead direct your funds toward achieving future goals, i.e., future consumption.

Saving is aimed at achieving short-term goals and ensuring quick access to funds for unforeseen expenses or everyday needs in a future period. Funds are kept in a secure place using appropriate saving tools, most often bearing minimum returns. Investing, on the other hand, aims to increase the value of the invested funds. This can be achieved by placing money into various financial instruments. Although riskier, they have greater potential for increasing the value of the invested funds - something that saving tools cannot provide.

 

2.      Use the power of compound interest

According to a quote often attributed to Albert Einstein, compound interest is the eighth wonder of the world. And for good reason - through its mechanism, the growth of invested funds accelerates over time, with the effect becoming especially visible in the long term.

Compound interest is based on reinvestment of returns, which may come from interest, dividends, rents, and so on. Imagine you have a deposit or investment, and instead of using the income, you allow it to work for you. Each subsequent year, the interest or profit is calculated on a larger amount, which includes both your initial funds and the income accumulated to date. For example, if you invest 1,000 EUR at a 5% annual interest rate, the first year's interest would be 50 EUR, which remains in your account. So, the next year, interest will be calculated on 1,050 EUR.

The mechanism is the same when investing in financial instruments. When you reinvest the income earned from your investment, you add those funds to your already invested capital. Thus, returns are calculated on the new, larger sum that includes the additionally invested funds. The effect of compound interest increases over time, because the longer the period, the greater the accumulation.

 

3.      Define your investment goals

As with other areas of life, it is important in investing to know what you are striving for - in other words, what your investment goals are. Naturally, they should be realistic and specific- only then will they be achievable. Properly defining them is the foundation of an effective investment strategy. There are three important aspects you need to consider:

·         The timeframe of the investment - i.e. how long you plan to hold the investment, is a determining factor. For short-term goals up to 3 years, it is not advisable to invest in riskier financial instruments. Generally, investment horizons are categorized as short-term - up to 5 years, medium-term - between 5 and 10 years, and long-term - over 10 years.

·         These timeframes are not fixed and depend on many factors, such as risk tolerance, the goals of the investment itself, and the characteristics of the investment instruments.

·         Risk assessment, where, in addition to your personal risk tolerance (your willingness to take risks), you must also consider the required level of risk associated with achieving your goals, and your risk capacity— i.e. your ability to bear losses without causing difficulties in your everyday life.

·         Return on investments and/or profitability, expressed as a percentage ratio between the amount invested and the profit realized for the entire investment period and on an annual basis, respectively.

 

Investment goals can be categorized as follows:

·         Preserving capital: The aim here is to minimize the risk of losing funds you already have, usually through more conservative instruments like government securities, money market funds, and others.

·         Generating passive income: This goal is about receiving regular additional income from securities—dividends, coupon payments, or rental income.

·         Growing the invested capital: This is focused on long-term growth of the value of the invested funds. The goal here is to achieve returns that, at a minimum, protect you from inflation, so you can preserve the purchasing power of your money. It is important to note that the pursuit of higher returns is usually accompanied by higher risk, which requires careful balancing between potential profit and the risk of losses. Commonly used for this purpose are financial instruments such as stocks, corporate bonds, exchange-traded funds (ETFs), as well as shares in investment funds.

 

4.      Build your financial foundation

Investing is like building a house—without a solid foundation, the risk is significant. That is why you must first create a stable base that will prepare you for unforeseen financial shocks and provide you with peace of mind.

·         Establish and maintain a financial buffer: It is advisable to have savings that cover necessary living expenses for at least six months to ensure stability in unforeseen situations. People with freelance jobs or irregular income might aim for a buffer that lasts even longer. This can prevent the need to sell investment assets at an inopportune time, such as during a market downturn.

·         Evaluate the costs of your credit obligations: Carefully assess your financial position, the terms of your loans, and their cost before starting to invest. A common recommendation is to repay high-interest debt first, since interest rates are typically higher than the expected return from most investments. Doing so reduces unnecessary financial losses and provides a stronger foundation for building your investment portfolio.

 

5.      Invest wisely and with awareness!

Never invest in something you do not understand—this is a fundamental piece of advice for all beginner investors. Before putting your money into anything, you must thoroughly familiarize yourself with the different types of investment opportunities, how financial markets work, and the nature and characteristics of various financial instruments.

Be aware that there are different factors that reduce the actual income you receive from your investments. These include inflation, fees and commissions associated with investing, and taxes, where applicable. Only by taking these into account can you determine the real growth of your funds over time.

When investing, your funds are exposed to risk, which means you could lose part or even all of the invested amount. That is why every investment decision should be accompanied by a comprehensive review, deep consideration, and evaluation of your financial situation, goals, and risk profile.