If you are considering to start trading stocks with a short-term horizon, instead of investing in stocks or other instruments for the long-term, then you should trade in stocks using the money in your ‘discretionary fund’.Before you set up your discretionary fund, also known as ‘play money’, you should set up your ‘rainy-day fund’ and even a portfolio of meaningful size for long-term investing.
Step 1: Set up your ‘rainy-day fund’
The first and foremost target for anyone is to have enough liquid assets to constitute her ‘rainy-day fund’.
You should set aside the requisite money for a rainy-day fund in term deposits, low-risk fixed-income instruments or cash. If the rainy-day fund comprises of a small portion of higher-risk equity exposure, then such instruments should be highly-diversified. It should cover at least six months of expenses to deal with any unexpected emergencies (such as unemployment, illness) that might arise in your life as well as in your dependent family members’ lives. The rainy-day fund would also include six-months worth of any monthly payment commitments that you might be having towards your mortgages, loans or insurance premiums.
If you specifically want your rainy-day fund to have an exposure to stocks, then such exposure should happen through index funds. You should ensure that such exposure is highly diversified, and the proportion of stocks is minimal while the exposure to bonds is comparatively more. It is not easy to construct such a low-risk, diversified portfolio, and hence you may think to delegate this task by investing all or a part of your rainy-day fund with a digital investment management firm, such as our firm QuietGrowth, in a lower-risk portfolio.
Given the modest size of your rainy-day fund, seeking the services of a high-quality human investment adviser for setting up and maintaining your rainy-day fund can be expensive. For more information, refer to our blog post: What is a rainy-day fund?
Step 2: Invest in a diversified portfolio for the long-term
Only after you have sufficient money for a rainy-day fund, you should consider investing in a more risky portfolio, preferably a risk-optimised, highly-diversified portfolio for the long-term. You may think to delegate this task to a digital investment management firm, such as our firm QuietGrowth. Else, you may seek the services of a high-quality human investment adviser on an ongoing basis.
Step 3: Set up your ‘discretionary fund’
Only after you are on-course with your long-term investing goals, you should start to consider some part of your wealth as ‘play money’. The amount in your discretionary fund can go towards investing in risky opportunities in which you personally believe and understand, such as a specific stock, a personal loan for a relatively-higher interest to a friend, or a business venture of your friend. The discretionary fund should be of a size that you are comfortable with.
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