Once you decide to invest, it is imperative that you first understand why you are investing before you decide what to invest in. You must have a reason or a purpose or driving force behind your actions. If you have a driving force that you believe in, it will be much harder for a person or a situation to derail you from your course.
Throughout your investing timeframe there will be many things that attempt to sidetrack you from your path, and it is your ability to stay the course that will ultimately dictate your success or failure. Before you actually begin investing, here are three factors to consider when determining your drive to invest:
Know Your Time Frame
Knowing the time frame for your investments is key to finding the right investments to implement. By understanding the reasons you are investing, you can start to work backwards to what you are investing in. (For more, see: How to Pick Your Investments.)
For example, if you are saving and investing for retirement and are currently in your 30s, you have plenty of time to reach your goal. You don’t have to worry about the short-term fluctuations of the markets. Having a long time frame to reach your goal allows you to be more aggressive with your investments.
If you are 30 and looking to buy a home in the next three years, your time frame for investing should be much shorter than in the previous example. You’ll need to be more judicious with the money that you are saving for this goal and probably shouldn’t take too much risk.
My friends recently sold a house and were looking to invest the proceeds, so they asked me what I thought they should invest in. They had several recommendations from other people who were investing in an assortment of things and wanted my advice. Before giving them any recommendations, I first asked them what their purpose was with the money they were investing.
They told me that they were looking to buy another home in the next two to three years and wanted to use the money as a down payment. They hoped to grow the money a bit before doing so. Since they needed the money in the next two to three years, this was not money with which they could afford to take a big loss. We ultimately decided it was not a good decision to take a lot of risk with this money.
Now, imagine if we had invested that money in some type of risky investment. There would be a potential upside, but what if the investment took a downturn over the next two years and they lost 20%, 30%, or even 40% of their money? They might not be able to buy the home they were planning to.
The point is, if you don’t know why you are investing and are simply trying to get the greatest potential return on your money, you might find yourself in a bad situation. Sometimes it’s better to focus on getting a return of your money and not a return on your money.
When investing, it seems like it is impossible not to second guess yourself. You will constantly be told about the next big opportunity, your friends will tell you about a stock tip they heard on TV, or a business they are starting in which you should invest. Every idea you hear about will be told through the rose colored lenses of optimism. You must be vigilant to make sure you are doing your proper due diligence on any of these opportunities, and ensure that sure they fit into your investment portfolio, and not someone else’s. (For more, see: 4 Steps to Creating a Better Investment Strategy.)
Market timing is a losing proposition. Even if the market does take a downturn over the next year, it will be okay if you’ve properly allocated your assets into the right buckets based on their purpose. The buckets that might be hurt in this event won’t be needed for a long time, so you aren’t worried about them making an immediate come back.
If you know the “why” of your investments, you’ll be able to reference that “why” whenever someone tries to pull you in a different direction. And the less directions you are being pulled in, the better.
Invest to Increase Your Quality of Life
There are three main reasons you invest:
- Maintain purchasing power
- Reach long-term goals
- Increase quality of life
Increasing the quality of life is the final reason you need to understand the reason you are investing. Your investments should not increase your stress levels. If you are taking on more risk than you can handle, and that risk is causing you stress, you are not investing correctly. Investing should be done to increase the quality of your life, not decrease it by adding unwanted stress.
By understanding why you’re investing, and by properly implementing the right investments to match up with those reasons, you will be able to simultaneously improve the quality of your life without greatly increasing your stress. The reason for this is simple. You will have a plan and you stick to it:
- You know how long your time horizon is, so you aren’t confused about when you’ll need that money.
- You know that you have the right investments in place for your needs, so you can avoid the distractions.
- And you know that you have a plan in place for reaching your goals, so you can sleep well at night.
Before you get lost in the endless barrage of great ideas for your investment portfolio, take a little time out and think about why you are investing in the first place. Ask yourself what that money will be used for in the future and how comfortable you’d be willing to put it at risk. If you understand this, you will be able to invest smarter and use your money in the most fitting way way for your investments needs. (For more from this author, see: How Money Can Buy You Happiness.)