1. Can you afford to invest?
You’ve probably heard the saying, “It takes money to make money.” And when it comes to investing, it’s true. So the first thing you need to determine is whether you have money to invest.
If you have consumer debt (such as credit card debt), or if you don’t have an emergency fund, then you probably need to prioritize those items before you can think about investing. Going into debt, or staying in debt, so that you can invest money usually doesn’t make sense.
2. Why do you want to invest?
Of course, you want to make money. But what do you want the money for? Are you trying to save for a down payment on a home? Or maybe you want to save for your child’s college education. Or perhaps you’re thinking about your retirement years.
Knowing what the money is intended for will help you decide on your investment path. If you’re saving for a down payment on a home that you plan to buy in the next five years, your investment vehicles should be dramatically different from the investment vehicles for a retirement that’s thirty years away.
3. What is your risk tolerance?
As you probably know from watching the news, the economy goes through ups and downs, and consequently, so do investments. Prices inevitably come down and go up. Every investor faces the possibility of losing the money they’ve invested. But some people are more comfortable with that risk than others.
Investment experts preach the importance of staying the course during tough economic times. This makes sense, because if you invest $10,000 and the market takes a dive, your investment may only be worth $8,000 overnight. If you panic and immediately withdraw your money, you’ve sustained a 20% loss. But if you leave your investment untouched and give the market time to recover, you may eventually find that your investment is worth $12,000, for a 20% gain.
Some investments are more likely to react strongly to various economic factors, making them more volatile. If you have a high risk tolerance, you are more likely to be able to handle volatile investments with a level head. However, if you have a low risk tolerance, it may make sense to avoid such volatile investments since even if you ride out the tough times, you are likely to experience high levels of stress.
4. What types of investments are out there?
If you’re completely new to investing, you’ll need to learn the basics, including the definitions of a stock, bond, and mutual fund, which are the most likely long-term investment vehicles you’ll be interested in. In simplistic terms, a stock is a share in the ownership of a company; an investor who buys stock in a company can make money if the value of the stock goes up. A bond is essentially a loan from the investor to the issuer of the bond, with the investor making money in the form of interest paid by the issuer. A mutual fund is a professionally managed investment that pools together money from many investors to buy assets such as stocks and bonds. Most mutual funds have a specific focus – for example, S&P 500 funds aim to mirror the make up of the Standard & Poor’s 500 stock market index, while an income mutual fund aims to acquire assets that produce income for its investors.
Other types of investments include certificates of deposit (“CD”), which you can get at most banks and offer a higher rate of interest than savings accounts, U.S. Savings bonds, which are bonds issued by the U.S. government, precious metals, real estate and more.
Determining the best investment vehicle for your needs requires an assessment of your goals, your risk tolerance, how much money you can afford to invest, and when you will need access to your money. You will also need to consider asset allocation.
5. What is asset allocation?
Experts recommend against putting all of your investment eggs in one basket, to reduce the risk of losing all of your money at once. Allocating your money to different investment vehicles is called diversification, and can help to maximize your gain while minimizing the risk of loss.
Asset allocation assumes that someone who doesn’t need access to their investment money for a long time can make riskier investments than someone who will need their money in a few years, because the long-term investor has time to wait out a downturn in the market if one occurs. The ratio of risky to comparatively safe investments is largely dependent on the amount of time the investor is willing to leave the money untouched. In fact, there are now many mutual funds – called target date funds – that are designed to handle asset allocation for investors. Target date funds have a specific end date, and the ratio of investments held by the fund changes over time, becoming more conservative as the target date approaches.
7. What fees are you willing to pay?
Investing almost always has a cost, especially if you are investing in stocks or bonds. Unless you are buying directly from the company or issuer, you will have to pay a fee to a brokerage or investment company, who will handle the actual buying and selling of the stocks and bonds for you. Many experts recommend mutual funds to beginning investors because they are relatively easy to understand, easy to buy, and costs are generally transparent. Online transactions may have the lowest cost, but generally require you to know exactly what you want to do.
A financial advisor may be able to guide you to the best investment vehicles for you. However, make sure your advisor is transparent about how he gets paid. If he is getting paid by the company he is recommending you invest in, his advice may not be objective. Independent advisors who get paid a flat fee regardless of their recommendations are available and may be the most reliable.