I for Insights Into Investing

I for Insights Into Investing
Personal Finance from A to Z
Eileen St. Pierre, The Everyday Financial Planner

Every once in a while I’ll think about the students I met during my college professor days and smile.  Like the young woman from Iowa who had $1,000 and wanted some advice on how to invest it.  I asked her if she had an emergency savings account (she would be graduating soon).  She said no.  I told her to put the money there.  Only after funding this account should she think about investing, I said.  She left disappointed.

IaInvesting is a lot more than picking that one stock that’s going to shoot through the roof and allow you to retire at 30.  Investing is a process that helps you achieve your financial goals.  The first step in investing is determining what your financial goals are, such as making a down payment on your first home or having a secure retirement.

Save consistently.  

For the average investor, the simplest and easiest way to build assets is to save consistently.  Set aside a certain amount of money each month to fund your financial goals.  Have the money automatically withdrawn from your checking or savings account by your investment company if you don’t think you will be disciplined enough to do it yourself.

  • If the money is for your retirement, have the money taken directly out of your paycheck and placed into your 401(k), 403(b) or 457 plan, taking advantage of any employer match (you’ll also lower your taxes).
  • This type of investing is called “dollar cost averaging” and helps you avoid having to time the market when buying securities.  After a month or two you’ll realize that you have adjusted your spending habits to the slight drop in take-home pay.

Know your investing time horizon.

It’s important to know how long you will need to invest your money to achieve your financial goal.  This will determine the types of securities you choose for your investments.

  • For a short term goal, like saving for a down payment on a house, safety of principal is most important so you would invest the money in a low-risk investment like a money market account, sacrificing some return.
  • On the other hand, if you are investing for your retirement, you will need to earn a high enough return to offset inflation and rising medical costs, and make sure your money grows enough so that it lasts.  This will require investing some part of your retirement portfolio in stocks.

Understand your risk tolerance.

It’s now a fact of life – investing in the stock market has become a roller coaster ride.  You need to determine how much risk you are willing to take on to reach your financial goals.

  • Stocks are riskier than bonds and bank CDs, but we expect to earn a higher return on stocks to compensate us for that risk.  That’s the trade-off.
  • If you are not willing to take on enough risk in your long-term investment portfolio, then you may fall short of your financial goal.  Then you will have to save more and/or lower your expectations.

Diversify! 

Retirement nest eggYou’ve heard the saying “Don’t put all your eggs in one basket.”  This means you want to hold a diversified investment portfolio.  You need to hold enough different securities so that if one performs badly, it will not drag down your entire portfolio.  This doesn’t mean you won’t lose money, but diversification can help minimize your losses.

  • The average investor can build a diversified investment portfolio a lot cheaper using mutual funds or ETFs (exchange-traded funds) than buying individual securities.
  • A mutual fund or ETF will hold a large number of securities, so when you buy into the fund, you will own a share of all of these securities.
  • Just make sure you understand what types of securities the fund invests in and the total cost of your investment including mutual fund fees or ETF trading commissions.

Everyone has the capability to be a successful investor.  Remember the lesson my student learned many years ago.  Investing is a disciplined process.  Take your time and make educated decisions.  You are certainly welcome to make the glamorous investment that promises to make lots of money quickly.  Just be prepared to lose it all.

Visit my Basic Financial Management page for more information.