Three questions to ask yourself before you begin investing
Before you move a single cent into an investment vehicle you need to sit down and think long and hard about what you are doing and ask yourself several questions. You probably think these questions are something like “What mutual fund is the best,” but in reality the questions that you should be starting with are far more basic.
When do you need the money?
Before you stick money into certificate of deposits (CDs), stocks, bonds or under your mattress you should consider the time frame in which you plan to use the money. Are you panning to use it in 6 months? In a year? In 3 years? In 10? Sometime when you retire? Consider these as rough guidelines to determining your investment time frame.
Short term - less than 3 years
intermediate - 3 to 10 years
long term - greater than 10 years
Whatever time frame you pick will affect your choice of investment vehicle. Some investment types such as CDs make your money inaccessible for the duration of the CD. For example, if you invest in a 1-year CD, then you can not touch that money for 1 year or you will pay a significant penalty on the interest. Other types of investments such as stocks experience regular fluctuations in their price, which means that in the short term it is possible that the money you investmented will actually decrease. However, over the long term the stock market almost always increases in value.
Keeping in mind this idea that investments do not automatically garuntee returns brings us to the second question that you must consider.
How much risk are you willing to accept?
All investment options carry risk. Generally speaking the more risk that a given investment carries, the higher the potential return. The lower the risk the lower the potential return. The higher return rate is your reward for absorbing the risk that the investment will fail.
If you don’t want to lose your money, select lower risk investments such as savings accounts or CDs. If short term risk is acceptable to you in exchange for long term growth potential than the stock market is a good option.
Stocks are a favorite investment choice for many people and historically yield good returns. However don’t assume that if you just pick a stock and throw money at it that you will be living the high life in retirement. Consider carefully the third question.
How much effort are you willing to put in?
I’m not going to kid you, proper investing takes effort. It takes effort to select an investment vehicle and it takes effort to manage it. Safer investment options such as savings accounts and CDs require much less effort to research and manage than stocks. Also the more buying and selling you plan on doing the more effort you are going to have to expend. In other words, please don’t take up day trading unless you are willing to expend the effort to understand exactly what you are buying and why you are buying it. If you don’t understand what you are doing then you aren’t investing you are speculating.
Now, if you are rather lazy like me there is another option for you. Index funds. These are mutual funds that basically track the stock market as a whole. This means that are you are absolutely not going to be able to beat the market with an index fund. On the other hand it does mean that you will do just as well as the market. Yes, you will have good years and you will have bad years. But in the end, if you are investing for the long run, you’ll wind up doing pretty well for yourself.
