5 Things You Must Know Before You Start Investing

5 Things You Must Know Before You Start Investing

Looking back, one of the biggest investing mistakes I made was investing before I was ready.

I didn’t know enough to start investing, but I did it anyway.

So if you’re wondering how to start investing, be sure you can properly answer the following five questions before investing a penny…

1.  How long is it until you need the money?

How you invest money is impacted by the time period until you need to access an investment.

  • If you need the money in a year, something more safe and secure like a CD or a high interest savings account would be best.
  • If you don’t need the money for 2-3 years, you could try some short term bond funds or something more creative like investing with Lending Club.
  • If you don’t need the money for 5-10 years, the stock market might be the best place for the investment.

2.  What is your risk tolerance?

Understandably, this is hard to really answer.

Basically, when the stock market is going up, everyone feels like they have a high risk tolerance so they invest in the riskiest stocks (that also bring the biggest returns).

However, when the market starts to drop, or worse yet – plummet, you’ll get a true look at your real investing risk temperament.

If you are the kind of a person who will sell your stocks when the market is dropping then you MUST consider alternative forms of investments or a more conservative investment plan.

Why?  You will sell only at low times.  Markets go up and markets go down.  If you’ll hold when the market is up and sell when the market is down, it will be hard to have a profitable investment.

3.  What do you plan to do with the money?

Most of us probably think all money is important, but with some funds, it is more crucial to protect that investment.  For example, if I have a few spare dollars that I’m investing just for fun, I’ll treat that money differently than my life savings when I’m 70 years old.  An investor in his or her early 20’s will have a very different investment plan than someone in her 60’s.

Don’t invest the money until you know what the money is for.  You might decide to invest it when you have credit card debt and then realize that your money is better served paying off your debt.  Think first.  Act second.

4.  Do you have a basic understanding of the investment?

One of the biggest mistakes I made when I started investing was that I did what my financial advisor told me.  Look, I understand that my financial advisor was a smart guy and he knew a lot about investing, but I wasn’t very smart because I did what he said.

Why?

I did what he said because he said it, not because it made sense to me.

I think before you invest a dollar in anything you should read at least one book on the topic.

For example, if you were considering investing in the stock market, you’d want to know about bonds, index funds, mutual funds, and even the major categories of mutual funds.

Without at least a basic knowledge, it will be hard to make informed decisions.

5.  What are the fees associated with this investment?

Before investing in something, you want to know if a person has any financial benefit for giving you a piece of advice.  Going back to my financial advisor, he suggested only front end load funds.  Those funds paid him well.  In the end, I didn’t feel like I was represented well.  It’s not his fault, it’s my own for not asking how do you get paid?  What fees are associated with this investment?

Investing is not something you want to rush into.  Once you have done the appropriate research, you should be ready to confidently proceed with your first investment.

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6 Comments
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  1. Craig – This is a great list. I also think one hugely important and often overlooked or misunderstood factor is asset allocation. Investment pros often say this is the single most important factor in a person’s investing success. Along those lines, here’s a question for others: if you’ve figured out the right asset allocation for you, how did you do so? What online asset allocation calculator have you found helpful? Financial planner friends of mine tell me that even with their proprietary software, they have to customize their client recommendations based on their conviction that the typical asset classes are no longer sufficient.

  2. Really great list here! I think numbers 1-3 are the typical questions people need to ask themselves when they are going to begin investing or allocating resources.

    Numbers 4 and 5, now those are the real secret gems that many people overlook! You absolutely must learn about what it is you are investing your money in. Unfortunately so many people get involved in deals without understanding all the ins and outs and if it will be a good deal for them. Just because it works for somebody else’s financial configuration doesn’t mean its right for you. Then of course number 5, know how the person giving you advice is getting compensated… That’s why I always recommend a fee based financial planner instead of someone who offers low or no up front costs but then recoups them through commissions… How do you know if that investment advice they give really is the best one for You.

  3. I think that many investors would fail #’s 2 and 4. We often just follow along with whatever the crowd is doing, or what an advisor suggests – even if it doesn’t fit our risk tolerance.

    Of course, most people don’t understand what they invest in (you’re definitely weren’t alone, there)! That’s why the market can crumble and everyone points the finger claiming that they didn’t understand the risks they were taking.

    If someone follows what you have laid out, then they will be ahead of many “seasoned” investors!

  4. You should also know the difference between good and poor investments. Read books, blogs, financial magazines, etc. If you don’t have a formal financial education.

  5. I thought I was ready when I started investing (just last year), but it turns out I had some more to learn. For example my actual risk tolerance is just a bit lower than what I had initially assessed. Also I didn’t research the fees well enough, I am charged 2% annually where other funds charge 1.5% or 1.75%.

  6. I think investing should always be made with money you dont need. I hear it all the time that family has lost their house because the husbands invests.

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