A Strategy for How To Invest Money
Ok, how to figure out this investing thing?
One of the biggest questions I get asked is how to invest. The answer isn’t as simple as choosing an awesome stock.
It’s first building a solid financial foundation by doing the following:
Please Note: The information in this blog is meant for educational purposes only. The information is not intended to be investment advice. If you are looking for investment advice, I encourage you to talk to a financial professional.
Create a spending plan for current and future expenses.
If you don’t have a spending plan, you have no idea how much money you need to manage your life financially. You will be caught off guard by upcoming expenses you didn’t plan for, like vacations, holidays, and car repairs.
When this happens, you may end up cashing out of your investments early to cover the costs. So you end up robbing your future goals to cover current unplanned expenses. Before you invest your money, make sure you have a spending plan reflecting your current and future spending.
If you’re unsure where to start, read “How To Create a Budget In 7 Steps.”
Develop a savings plan to cover unexpected costs.
Life is going to happen. Your car WILL need repairs, and you WILL get surprise expenses. Savings is your “Financial Life Cushion,” so you can pay costs with cash instead of high-interest debts. Savings ensure that you don’t have to drain your investments when you have a financial need, essentially draining your financial goals. Before investing your money, create a spending plan to handle life’s financial hiccups.
Creating a savings plan doesn’t have to be complicated. Read “How to Create A Successful Savings Plan in 3 Steps” to get started.
Pay off high-interest debts.
It makes no sense to invest and earn 10%+ AND pay 20%+ in credit card interest. The best thing you can do for your money is to pay off the high-interest debt that is sucking the life out of your wealth-building goals. Before investing your money in the stock market, pay off high-interest credit card debt at a minimum.
If you have high-interest credit card debt, read “How to Create a Debt Payoff Strategy Plan” to help you find the best payoff plan.
Next, use the 4 questions below to create an investment strategy:
1. What’s your plan for the money?
Decide on the goal of the amount of money you’re investing before you invest your money. Do you plan to use the money for your kid’s college, to retire, or to retire early?
Your goal, not the hottest investment, should guide which investment you choose.
2. When will you use the money?
Once you’ve nailed down your goal for the money, the next thing to do is decide when you will use the money. Do this before you invest your money. The time frame you want to use the money is an essential factor in determining where to invest your money.
Below is a general rule of thumb about money decisions based on time frames:
Using the money in 5 years or less: General guidance is to consider non-stock market accounts like checking, savings, CDs, or money markets. Why? Because the stock market can be volatile in a 5-year timeframe.
The last thing you want is to need your money the year the market dips 30% (rough average dip in a recession), and you have less money than you need.
Using the money in 5-10 years: The general rule of thumb is to consider a balance of stock market investing and non-stock market investing (for example, bonds).
Stock market and non-stock market investments like bonds often (but not always) work like a see-saw. When the stock market is up, the non-stock market investments like bonds are typically down (economic booms).
When non-stock market investments like bonds are up, the stock market often is down (recession). Having a balance of both helps ensure that no matter where the market is moving, something in your account can positively respond.
Using the money in 10+ years: These are typically long-term goals like college savings and retirement. General guidance is to consider investing in the stock market (still with some diversity in other investments). The percentage and how you invest in the stock market depend on your answers to the next questions.
3. How comfortable are you with the ups and downs in the market?
Remember, this is YOUR investment strategy, not anyone else’s. You need to honestly assess how comfortable you are with seeing your money go up and down every time you look at your investments online.
If you’re not sure, here’s a starter question:
How comfortable are you if you have $100K invested and it goes down to $70K for about 18 months? This is what happens on average during a recession. In the history of the stock market, the market rebounded after recessions. How well you emotionally handle the dips in the market, not the highs, should determine how you invest.
I’ve found someone’s risk tolerance is often linked to the investment goal he or she cares about the most:
Conservative- Typically cares the most about preserving money. Most people in this category emotionally struggle with swings in the market.
Moderate- I find this investor cares the most about consistency. They don't like market volatility, but they can emotionally tolerate the market ups and downs for consistent long-term growth.
Aggressive- This investor cares the most about growth. They can emotionally handle significant ups and downs of the market for the ultimate prize of maximum growth.
If you're not sure where you stand, consider doing a risk tolerance questionnaire. Do this before you invest your money, so you can comfortably sleep at night no matter what’s going on in the stock market.
4. How much time and energy do you want to spend investing?
All investments will require some level of research. But the amount of time you spend researching, selecting, and monitoring varies depending on your investment choices. Deciding how much time you want to spend BEFORE investing your money will save you a lot of headaches in the long run.
If you’re looking to learn more about investing, two of my favorite tools for beginners are Investopedia and Morningstar Investing Classroom.
My all-time favorite investment book is The Intelligent Investor by Benjamin Graham. Benjamin Graham was Warren Buffet’s mentor. Even though Mr. Graham wrote the book in 1949, the advice is timeless, and investors use his advice today.
You can DIY it and choose research tools like Yahoo Finance, Google Finance, the American Association of Individual Investors, and Morningstar.
If you want to be involved in investment choices but want help researching and selecting investments, there are plenty of online investing options available if you wish to invest in stocks, ETFs, or mutual funds, as well as other investments.
If you want more investment help, you can either work with a human investment advisor or work with an online investment advisor.
IN CONCLUSION
There’s more that goes into an investment decision than just picking an investment. Before you invest your money, make sure you have a strong money management foundation such as:
A spending plan
Savings plans for a different savings goal
Paying off high-interest debts
Once you have a strong money foundation, next think through an investment strategy using the 4 Investment Planning questions as a starting point:
What do you plan to do with the money?
When will you use the money?
How comfortable are you with the ups and downs of the stock market?
How much time and energy do you have/want to spend investing?
Going through this process ensures you invest based on your future goals rather than using investments to pay for past or present money needs.
