There’s no shortage of investment recommendations out there.
Your family members have opinions. Your friend that works for that financial company has suggestions. The internet is full of articles claiming to know what you should be investing in.
With all of that input, how do you decide whether any individual investment is worth your money?
You get your cynic on and you ask a lot of questions. That’s how.
Here are eight questions to ask yourself before investing in anything.
1. What Are You Investing For?
It’s easy to hear someone talk about a particular investment and get caught up in the excitement of making a lot of money. Who doesn’t love a hot tip?
But it’s helpful to take a step back and remind yourself what you’re really investing for. Because the goal is never to beat the market or even to maximize your return.
Your goal is personal. You want to retire with enough money to travel. Or you want to send your kids to college.
Whatever it is, your real goal is simply having a certain amount of money by a certain date so that you can do something important with your life.
Keep your focus on that goal and always remember that any investment you choose should serve that goal and nothing else.
2. How Are You Feeling as You Consider This Investment?
Investing is never going to be completely emotionless. There are a lot of ups and downs and it’s impossible to keep your cool through all of it.
But you should, to the best of your ability, avoid making any big investment decisions when your emotions are running high.
So, as you consider any particular investment, ask yourself how you’re feeling. Are you scared? Exhilarated? Anxious? Confused?
The stronger your emotions, the better off you are sleeping on the decision and waiting until you can think with a calmer mind.
3. Do You Understand This Investment?
Never invest in anything you don’t understand.
Seriously. Just don’t.
The best investments are often the simplest. Many financial professionals would like you to believe otherwise, but complicated investments typically have higher costs, lower returns, and more unintended consequences.
Keep it simple. If you can’t explain how the investment works in a minute or less, you should walk away.
4. How Much Does This Investment Cost?
Cost is the single best predictor of future return. The less an investment costs, the more likely it is to provide superior returns.
Which means that you should be doing everything you can to minimize the cost of your investments.
This is another reason to avoid investments you don’t understand. Complicated investments usually have a lot of moving parts, and moving parts usually lead to hidden fees that devastate your returns.
You can learn more about the various costs to consider here: Eight Investing Fees to Watch out For.
5. How Does It Fit in with Your Other Investments?
No investment decision should be made in isolation. No investment is “good” or “bad.” What matters is how it fits into your overall plan and how your entire portfolio of investments works together to help you reach your goals.
For example, your employer might offer you the opportunity to buy employer stock at a discount. That sounds like a no-brainer on the surface, but there are some other factors you need to consider:
- How will buying employer stock affect your overall asset allocation?
- Will buying employer stock tie too much of your financial future to the fate of your employer?
- What adjustments would you have to make to the rest of your portfolio to counterbalance those things?
- Will those adjustments cost money? Are they logistically difficult? Are they even possible?
Your objective is not to pick a bunch of good investments. Your objective is to build a portfolio of investments that work together to help you achieve your goals.
An investment is only worthwhile if it fits within that portfolio.
6. How Easily Can You Get Out of This Investment?
Switching mutual funds within a 401(k) is easy. There are almost never any trading fees and there are no tax consequences, so getting out of a bad decision is simple and usually cost-free.
Getting out of an investment within a taxable brokerage account can be trickier. The logistics are usually simple, but there are often trading fees and taxes to consider.
Getting out of something like whole life insurance can be a nightmare. Unless you’re many years in you will almost certainly lose money on the investment, and even if you make money you’ll likely owe taxes and maybe even surrender fees.
You shouldn’t be making frequent changes to your investment strategy, but you don’t want to unnecessarily lock yourself into anything either. Before you put your money into any individual investment, you should ask whether you’re able to get out and how much it would cost you.
7. What Is the Expertise and/or Motivation of the Person Recommending This Investment?
Always, ALWAYS consider the source of every investment recommendation you get.
Is it a friend or family member? A random blogger? Does this person have any real expertise?
Is it a financial professional? If so, how are they paid? Do they have a financial incentive to make this recommendation?
Whoever it is, does this person have a detailed understanding of your personal goals and your overall financial situation? Do they know what investment accounts you have? Do they know what other investments you hold?
There are many people who are happy to make all kinds of investment recommendations. Very few are in a position make a good one.
8. Is There Any Need to Change Your Current Investment Strategy?
You chose your current investments for a reason, right? Have your reasons changed? Have your circumstances changed?
Is there any reason at all to change what you’re already doing?
If you made thoughtful decisions from the beginning, the answer is most likely no. Your current investment strategy is almost certainly good enough, and there’s really no need to consider something new.
Warren Buffett is famous for saying that “Lethargy bordering on sloth remains the cornerstone of our investment style.”
When it comes to investing, doing nothing is often the best move.
Related Articles:
- Are You Ready for a Stock Market Crash?
- 401(k) Vesting: What It Is and Why It Matters
- 10 Things You Need to Do Before You Start Investing
Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.
The post Eight Questions to Ask Yourself Before Investing in Anything appeared first on The Simple Dollar.
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