“If you don’t know where you are going any road can take your there”
That quote is attributed to Lewis Carroll from the book Alice in Wonderland, and that same quote applies to investors. If you’re searching for the best way to invest money, you need a plan. As Admiral Painter says in the movie Hunt For Red October:
“Russians don’t take a dump, son, without a plan.”
So let’s lay out a plan.
Here’s your roadmap for deciding on the best way to invest money:
- Goal: What are you investing? How much are you trying to accumulate (be realistic).
- Timeline: How long are you planning on investing? When do you need to take money out of the investment.
- Risk Assessment: How much risk are you willing to take? More specifically, what level of price declines in your investments are you willing to live with? (I’ll give you a tool to determine this for yourself).
- Time investment: How much time are you willing to invest and monitor your investments? The less time you’re willing to spend, the more help you’ll need from a professional.
Now that you have the roadmap, let’s go into detail.
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White Goodman was able to grow Globo Gym with his “can-do attitude, a little elbow grease- and yes, a large inheritance from my father, Irv Goodman.” Most of us aren’t in that boat- we to invest for ourselves and grow the money over time. So, let’s start with the end in mind: what’s your goal?
Here are some possibilities:
- Buy a house, apartment or condo
- Accumulate money to start a business
- Save to fund retirement
Now, those are long-term goals. You may simply want to save to put money down on a new car or replace your laptop. But you need to be specific about the reason, because that will motivate you to put in the time and use self-discipline to reach your goal. Investing isn’t easy, so you need to have a reason.
Let’s assume that Julie wants to accumulate $15,000 over the next 8 years to put a down payment on a house.
Julie’s timeframe for investing is 8 years, and that’s an important number for several reasons. The shorter your timeline, the less you’re willing to spend on investment fees and other costs. Your timeline also impacts your risk tolerance. If your investing time horizon is short, you’ll have less time to make up for any losses you may incur along the way.
Mutual fund costs are a good example to illustrate this point. A mutual fund pulls together money from thousands of investors and purchases stocks, bonds, and other investments.
Most funds are designed as long-term investments (5 years or so). The cost of owning a mutual fund is recovered by “earning back” the expenses that you paid. As your fund generates dividends from stocks or interest payments from a bond, you’ll recover the cost of your investment.
If your expected holding period for an investment is less than five years, you probably should not consider a mutual fund investment.
How much risk are you willing to take? What level of price declines in your investments are you willing to live with?
Investment professionals are required to ask that question, and document the client’s answer. There are many ways to ask the question, but I like this version the best:
“If your investment went down 15% in one year, is that something you could live with?”
Now, you can fill in any percentage into that question. If you can’t live with 15%, for example, how about 10%? 7%?
What I’m getting at is that every investment fluctuates in value over time- some a lot, some not so much. Everybody loves the upside of being a risk taker (Money For Nothing), and we love getting our investment statements and reading that the value of our holdings went up. But can you also live with the downside of taking risk? Ask that question of yourself.
Bear in mind that the longer you invest for, the more time you have to make up for a short-term decline in the markets.
Your time investment
How much time are you willing to invest and monitor your investments? The less time you’re willing to spend, the more help you’ll need from a professional. Now, working with an investment advisor requires you to pay annual fees or commissions on transactions. If you’re not willing to stay on top of things yourself, these professionals are a great resource.
Where you go from here
Here are your next steps:
- Create a monthly budget, including a savings amount
- Accumulate $1,000 in savings, then start investing the amount over $1,000 (thanks, Dave Ramsey).
- Work with an online investment firm (Schwab, Betterment, others).
- Invest in a diversified portfolio of stocks and bond using mutual funds.
This post was originally posted on my Quora page.
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Dominic Alves, Winding Road (Ditchling Road, Hollinsbury) (CC By 2.0)