Making investment decisions isn’t easy, especially if you are just entering the game. When trying to find your way through the maize of investment options available today, there are some critical questions that you must answer concerning a lot of details that many people don’t think about until it’s too late. So, if you want to avoid the eternal pain of poor investment plans, ask yourself these seven questions:
1. “Why?” It’s a simple question, but it’s often the hardest one to answer. Why are you investing, and what do you hope to gain from it? In other words, you must set specific goals. Maybe you want to save for retirement, maybe you want to send your kids to college, or maybe you just want some breathing room from everyday expenses. Whatever the reason, it’s important that you define why you want to invest your money and what goals you wish to accomplish in doing so.
2. “What is my time frame?” When can you expect to earn a return on your money? This all depends on what kind of investments you make. Most of the forms of investments which you can cash out of at any time, such as stocks, bonds, and mutual funds, often leave you with the risk of not getting back all that you paid in. Many other investment options will limit or restrict the opportunities that you have to sell your holdings. Make sure you are aware of these before you enter the game.
3. “What am I going to get out of it?” How much can you realistically expect to earn on your investments? Having an unrealistic idea of playing the stock market and “striking it rich” could leave you simply striking out. Most earnings, as millions of people encountered in the past few years, are dependent upon the market, and can rise or drop based on market changes. Other investments, such as bonds, have fixed returns that aren’t as susceptible to market changes.
4. “What kind of earnings will you make?” Very few times when investing does a wad of cash appear in your mailbox, even if you’re successful. Often your success is paid to you in things such as potential for earnings growth, as in real estate purchases. Other times it can come through interest or dividends. Knowing the details of your payback can help you make better decisions when you are paying in.
5. “What’s my risk?” And here comes the basic balance in investing: risk versus reward. The higher the risk, the higher the potential reward. Overall, with most investments (especially those tied to stock market performance) there is no guarantee that you will get your money back or receive the earnings promised to you. Make sure that the risk you take is worth the reward that you expect to achieve.
6. “Is my money diversified?” We can all remember our mothers at some point or another saying, “Now, don’t put all your eggs in one basket.” Well, your mother’s wise words ring true in terms of investments as well. Certain types of investments do better in certain situations, so by diversifying your portfolio you are spreading your eggs across many baskets. That way if a certain industry tanks or a sector is struggling, you will have plenty of other baskets holding your money safe and sound.
7. “What is the effect of taxes on my investments?” Potential tax consequences are critical in making investment decisions. Your contributions to certain investments are tax-deductible, but there is no tax on the earnings. Other options work in the opposite way, in that your contributions are not taxed, but your earnings are. Certain bonds are exempt from state and local taxes, such as U.S. Savings Bonds, while others, such as municipal bonds, are exempt from federal income taxes and most state income taxes as well. Make sure that you are using your investments’ ability to avoid taxes in the most efficient ways possible.
Now that you know the questions, it’s up to you or your financial advisor to determine the answers. The important thing to remember is that the best answer to each one is whatever is best suited to you and your goals. Take the time to think through your decisions and all the alternatives. There is no standard pathway to success on the road of investments, but if you take the time to ask yourself or your advisor these seven questions, it will be a much smoother ride.
