Investing is an invaluable way to build wealth and reach your financial goals, but it is crucial that you know exactly what you are getting into before taking any steps.
Many investors make the common error of taking on too much risk or lacking a clear investment plan. Learn how to avoid these common missteps and make wise investment decisions.
Know Your Goals
One of the keys to smart investment decisions is knowing your goals. This could range from simply increasing retirement wealth or leaving an inheritance, all the way through to leaving an inheritance behind for future generations. Setting clear objectives makes sticking to an investing plan during times of market decline much simpler.
Follow-the-herd mentality is tempting when it comes to financial decisions, but rarely wise. A more prudent solution would be creating a comprehensive plan with your financial goals, risk tolerance and vision of wealth clearly stated within. Your plan should also indicate how much investment money you intend on allocating over time as well as which investor category best represents you (active or passive).
Before investing your money, decide where and when you would like it placed. For example, if your savings account or short-term CD needs are immediate, placing them there may be safer assets such as savings accounts or short-term CDs more suitable. Longer-term investments like stocks should be treated more like long-term investments. You also should decide whether you would rather engage in active or passive investing as studies have revealed that active investors tend to underperform diversified index funds over time.
An essential aspect of making smart investment decisions is keeping tabs on all of your expenses related to investments. While during boom times it may be easy to overlook these expenses, they add up over time and it is wise to regularly compare your investment expenses against returns received to ensure an equal balance between risk and reward.
One key to smart investment decisions is having a plan. It’s wise to have cash or high-interest savings accounts available in case something unexpected comes up, like losing your job or needing an expensive medical procedure. Furthermore, having these resources may help prevent selling stocks during an economic downturn that would prove more expensive over time.
Smart investors typically save six months’ income in an emergency fund as protection against unexpected events. To find the appropriate investments or formulate a financial plan for yourself, use Bankrate’s AdvisorMatch tool and get connected with a Certified Financial Planner.
Understand Your Risk Tolerance
Risk can have an immense effect on the returns you can expect to see with your money, with higher risks offering the potential of greater gains but also carrying greater drawbacks if something goes wrong. To determine what level of risk suits your goals and timeline while creating an optimal strategy tailored specifically to you can help to determine your returns. To identify this level comfortably for yourself work with a financial advisor who will develop an individualized strategy tailored to meet them all.
Typically, this process begins with an investment questionnaire that asks about your time horizon and need for funds; willingness to tolerate market volatility; comfort with staying invested through market declines; as well as your level of comfort staying invested for extended periods. Based on these responses, a score may be produced that provides a comprehensive assessment of risk tolerance; higher scores indicate more aggressive portfolios whereas lower scores reflect conservative portfolios.
Financial advisors can help determine your risk tolerance by reviewing both personal and family circumstances, as well as goals you’ve set for yourself. For example, if you’re saving for a home down payment next year in your 20s, they might recommend opting for riskier investments since you will likely have plenty of time to recover any losses caused by market fluctuation.
As with investments for retirement accounts, your primary objective should be to build your nest egg; however, once it comes time to fund living expenses during retirement you may want to focus more on protecting and preserving capital values of investments rather than increasing them.
That is why financial professionals must understand each client’s entire story, designing an investment portfolio to reflect it accurately. Furthermore, it is vital that clients be honest when filling out assessments because inaccurate assessments could result in mismatched investments that will hinder returns over time.
Diversify Your Investments
“Don’t put all your eggs in one basket” applies just as strongly to investing. Diversifying investments helps reduce risks of major losses while providing opportunities to reach financial goals over time.
Diversify your investments by selecting an array of asset classes such as stocks, bonds and cash or short-term investments like money markets. You can purchase these assets either directly or through funds that invest them. In addition, many investors use other investment vehicles like private equity, venture capital, precious metals and real estate for further diversification purposes.
Financial experts advise investing in all three asset classes by diversifying by market capitalization (small, medium and large caps), geography and sector. If investing in stocks, for instance, choose companies of differing sizes from various sectors, such as technology, consumer goods and health care. When considering bonds as investments, choose from among multiple maturities, credit qualities and durations to increase your diversification efforts.
Once you have decided on an asset allocation, be sure to periodically rebalance your portfolio to keep its percentages aligned with those originally assigned. If certain parts of your portfolio outshone others, more funds may need to be shifted towards underperforming sections in order to maintain your original allocation.
Diversification should not be used as a means of eliminating risk; nor will it guarantee higher returns or protect against losses. But it does help smooth out market fluctuations, increasing your odds that your long-term plan remains on course – which makes diversification so critical in reaching financial goals.
Create a Plan
Step one in making smart investment decisions is creating an investment plan. Mapping out your journey is crucial in life and investment alike; without clear guidance and vision from this guide to 401k gold ira rollover, you may make decisions that compromise your financial future. An investment plan helps identify goals, assess risk tolerance and create timelines.
Building an investment plan may seem complex, but it’s really just a series of questions you need answered before beginning the journey. You can take this on by yourself or with help from a financial advisor; either way, the effort put forth is more than worth your while as it will save you from investing in something you shouldn’t and allowing you to avoid learning the hard way!
As part of your investment plan, it is crucial that you consider your current financial status when creating an investment strategy. Doing so will give you an idea of the amount you can invest. Furthermore, accessibility of investments may impact which types you choose.
An important key is to break your goals down into short, intermediate, and long-term sections, whenever possible. This enables you to more efficiently align your bank accounts, brokerage accounts, and retirement funds with natural stages of life while preventing temptation from tapping into them early for quick gains that often come with steep penalties attached.
Knowing your tolerance for risk will be an integral factor in choosing investments to pursue, although no guarantees can be given as to which investments will produce positive returns.
Once you have identified your investment goals, timeline and risk tolerance level, the next step should be creating a portfolio of your own investments. This involves selecting suitable vehicles – and finding guidance from a trustworthy financial advisor can assist in this regard.