Investing money can be an effective way to build wealth. However, everyone has different incomes and budgets.
The first step is figuring out how much you should invest. The answer will vary depending on your goals, investment time horizon and risk tolerance. It should also depend on other financial priorities, like establishing an emergency fund and paying off debt.
Know Your Investment Goals
Having a clear investment goal gives you a purpose and helps you stick with your investing strategy, even when the market is volatile or when you’re tempted to make impulsive decisions. Having a clear financial plan also makes you more aware of the risks that come with investing and can help you avoid making mistakes.
You should identify your short- and long-term goals, focusing on investments that align with those timelines. It’s a good idea to invest in savings accounts and money-market funds for your short-term goals, while you may want to consider retirement or educational accounts for your longer-term investment needs (and to avoid steep penalties for accessing those accounts prematurely).
Your time horizon will impact the type of investments you can make; investing for retirement is often considered the ultimate long-term goal while buying a house or saving for a child’s college education might be more appropriate for shorter timelines. Review your goals regularly and adjust them as life events change.
Determine Your Risk Tolerance
The amount of risk you are willing to accept is an important factor in forming your investment strategy. It determines which investments may be suitable for you, and it can influence your emotions during market fluctuations.
It is not a fixed number, but rather a relative score that can change over time as your financial situation changes. It can also be influenced by your emotional resilience to losing money and your knowledge of investing.
To determine your risk tolerance, think about how you would feel if your investment returns were volatile. If you could handle a rough ride, you may be more tolerant of risk. If you would panic or sell out of your investments during a downturn, you may be less tolerant.
Your risk tolerance should be compared to your capacity for risk, which is determined by objective indicators such as your net worth, savings versus living expenses and sources of income. Your capacity for risk may decrease as you approach retirement or if you are saving for your children’s college education, for example.
Determine Your Time Frame
Regardless of your risk tolerance, it’s essential to have a grasp on how long you expect to hold onto investments. Known as your investment time horizon, this figure will help you determine the types of investments that make the most sense.
Depending on your goals, this time frame may be as short as a few months, or it could stretch out over decades. Generally, the shorter your investment time horizon is, the more conservative you should be with your assets, as you won’t have much time to recoup any potential losses.
However, as your investing time horizon gets longer, you can afford to take on more risk. When this happens, it’s important to understand how larger time frames impact daily price trends – and how to read those relationships.
Develop Your Knowledge of Investing
When investing, a lot of knowledge is required to understand the products and risks involved. Unlike savings accounts or certificates of deposit that require little knowledge, market-based investments such as stocks and bonds often involve complex financial concepts. Beginning investors should always be careful not to invest in anything that they don’t fully understand. They should also be wary of investment fads that are promoted through sensationalized news stories or the pronouncements of certain market pundits, as these may not stand the test of time.
Building your investment skills is not a quick process and requires patience. To help, one should always ask questions, debunk myths and study to stay up to date on the latest trends and changes in the investing industry. In addition, a new investor should also familiarize themselves with the various types of taxes involved in investing and develop a strong understanding of basic financial concepts. Taking these measures can ease the learning process and reduce the risk of losing money through bad investments.