Questions to ask before you buy.
So you want to get into the investment game and you’ve been sitting on the bench. The Standard & Poor’s 500 index is up around 18 percent this year through September and you’re apprehensive about getting back into the game now. Should you just run onto the field and start playing or wait for the coach to put you in at the right time?
The following are three essential questions that every investor should always consider before putting cash to work.
1. What is the money for?
It sounds simple enough, right? But there are many permutations to this foundational question since how you answer it will drive many other investing-related questions.
The answer correlates to the goal of the investment, whether it is buying a new car, saving for college, retirement or something else. It is important to be specific about the goal of the investment because each goal should have a timeline associated with it and each goal should be categorized as either a “survival” or a “lifestyle” goal.
- A survival goal is essential and must be achieved
- A lifestyle goal is discretionary in nature and there is flexibility in its timing
Each needs to be viewed alongside the amount of risk you can accept as an investor. If you are seeking a high return, then without a doubt there will be risk. Your expected risk and return must be weighed very carefully and understood completely … which leads to the next question.
2. When will I need the money?
The timing of when you will need to access the funds that make up your investment, either in full or in part, is the second question to ask yourself. This question relates to your investment time horizon.
Will you need the funds in the near-term, mid-term or long-term? There is no precise definition to the “term length” as much depends on personal preferences and the investment under consideration. However, here’s a reasonable yardstick:
- Near-term would be 18 months or less
- Mid-term would be two to five years
- Long-term would be five years or longer
As a rule of thumb, near-term requirements for cash should almost always be invested in very safe investments like money market funds, CDs, short-term bonds, etc. Since the expectation for return on these investments is typically small and so is the risk, staying on the sidelines can be a smart idea. As you move to mid-term and long-term needs for cash from your investments, you typically have a greater appetite to take on investment risk and the associated higher return. Again, careful examination of the goal and the understanding of the investment return and accompanying risk is paramount.
3. What investments align with my goals and investment horizon?
As mentioned earlier, if you need to have access to your investment within 18 months, you should strongly consider staying on the sidelines and keep your investment in cash. This is especially true if you cannot afford to accept any risk to your principle.
As your investment time horizon moves into the mid- and long-term range, the investment selection, investment strategy and corresponding risk need to be consistent with the goal for the funds. Often, the investment portfolio is comprised of several investment strategies which work in harmony to create a diversified portfolio that meets the risk and targeted return requirements to achieve your goal. For example, if you had a $100,000 and wanted it to grow to $135,000 in 5 years, it would require an annual growth rate of 6.2 percent. How to achieve that annual growth rate can be very complex in an investment environment of rising interest rates and the inherent risk of a sluggish economy.
Getting off the bench and back into the investment game successfully can be achievable for any investor, provided they a focus on what the money is for, when they will need to access the funds, and how to construct a portfolio that is well diversified and meets their risk parameters.
The opinions voiced in ” Ready to Invest ” are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate please consult your financial advisor prior to investing. All performance referenced is historical and is not guarantee of future results. All indices are unmanaged and may not be invested into directly.