Why are you investing? It's OK if you have many different answers to this question, but there is a big problem if you have no answer at all. Investing is like driving—it is best done with your eyes open!
Having clear reasons or purposes for investing is critical to investing successfully. Like training in a gym, investing can become difficult, tedious and even dangerous if you lack focus. In this article, we examine some common reasons for investing and suggest investments that fit those reasons.
No one knows whether the Social Security system will survive the coming decades. It is this uncertainty that forces us to plan for our own retirement. You need only open the newspaper to find out about a new bill that will cut government payouts. In these uncertain times, investing can be a tool to help you carve out a solid path to retirement. Three maxims apply to investing for your post-work years:
- The more years between today and your retirement, the more years your money has to grow. You have to keep in mind that you are fighting inflation when you are planning to retire. In other words, if you don't invest your money to outpace inflation, it won't be worth as much in the future.
- The older you are when you start, the more risk averse you will have to be. This means that you will likely use guaranteed investments such as debt securities, which have lower returns. By contrast, if you start young, you can take larger risks for (hopefully) larger gains.
- The earlier you start learning about investing, the easier it will be to pick it up. Financial professionals are difficult to choose and costly to keep, so it is best to manage your own affairs whenever possible.
Investing for retirement is similar to long-term investing. You want to find quality investment vehicles to buy and hold with the majority of your investment capital. Your retirement portfolio will actually be a mix of stocks, debt securities, index funds, and other money market instruments. This mix will change as you do, moving increasingly toward low-risk guaranteed investments as you age.
Achieving Short-Term Financial Goals
You don't always have to think long-term. Investing is as much a tool for shaping your present financial situation as it is for forming your future one. Do you want to buy a BMW next year? Do you want to go on a cruise? Wouldn't a vacation that was paid for with dividends feel nice?
Investing can be used as a way to enhance your employment income, helping you to buy the things you want. Because investing changes along with the investor's desired goals, this type of investing is not like retirement investing. Investing to achieve financial goals involves a blend of long-term and short-term investments. If you are investing in the hope of buying a house, you will almost certainly be looking at longer-term instruments. If you are investing to buy a new computer in the new year, you may want short-term investments that pay dividends or some high-yield bonds.
The caveat here is that you need to pinpoint your goals first. If you want to go on a vacation in a year, you have to sit down and figure out the cost of the vacation and then come up with an investing strategy to meet that goal. If you don't have a set goal, the money that should be going into that investment will doubtless be used for other purposes that seem more pressing at the time (Christmas presents, a night out and so on).
Investing to achieve financial goals can be very exciting and challenging. Combining the pressure of time constraints with the fact that you're not usually dealing with large sums of vital money (as in retirement investing), you may be less risk averse and more motivated to learn about higher-yield investments (growth stocks, shorting, etc.). Best of all, a tangible reward is at the end.
Reasons Not to Invest
Just as there are two main reasons to invest, there are two big reasons not to invest: debt or a lack of knowledge.
In the first case, it is a simple matter of math. Imagine that you have a $1,000 loan at 9% interest, and you get a $1,000 bonus. Should you invest it or should you pay down the debt? Short answer: Pay down the debt. If you invest it, the money has to make a return of well over 9% (not counting commissions and fees) to make it worthwhile.
When it comes to lack of knowledge, it is a matter of "Fools rush in where angels fear to tread." Throwing your money haphazardly into investments that you don't understand is a sure way to lose it quickly. To use an exercise analogy, you don't walk into a gym and lift 500 pounds your first day. In other words, your introduction to investing should follow the same incremental process as weight training.
Conclusion: Allowing for Change
Your reasons for investing are bound to change as you go through the ups and downs of life. This is an important process, because the only alterntive is to invest with no purpose, which will likely result in investing practices that reflect your uncertainty and cause your returns to suffer. Your reasons and goals will have to be reviewed and adjusted as your circumstances change. Even if nothing significant has changed, it is always helpful to reacquaint yourself with your reasons at regular intervals to see how you've progressed. Like running on a treadmill, investing gets easier and easier once you actually start.