In today’s world of easy access to information, stats, news and markets, many people decide to manage their own investments.
Some may DIY it because they think they can’t afford a money manager, while others just do it for the fun of it (hard to believe for some of you, I know). While it’s true that not everyone needs a money manager, before going down this path make sure you are honest with yourself about your capabilities. This isn’t all about your financial smarts; make sure you can handle the emotions that come along with a roller coaster stock market and have the time needed to successfully monitor your portfolio. Those who find investing intimidating, don’t have the time or stomach for it or have complex finances are probably best seeking out a professional.
However, managing your own investments can be done! Investing can be exciting and interesting but buyer/seller beware… it can also be extremely risky. A personal investing strategy based on your goals and needs can help minimize the risks and maximize your rewards. So before you invest a penny of your hard earned money, follow the below four steps.
1. Define your investing goals
Like most everything else in life, before you get started you have to know where you want to go. Investing is the same. Of course everyone’s ultimate goal of investing is to make money (that’s the definition of investing after all). But how you invest will be based on your specific goals. Start by listing them all out. This may be simple. The money you are investing is in a retirement account, therefore your only goal is to grow your money long term. Or you may be investing to pay for your child’s college tuition, to buy a vacation home, start a business or leave money for your family.
2. Figure out your cash needs
Once you’ve identified your goals, determine when you will need your money. If your goal is to save for a vacation home, you may need your money in two years for a down payment. If you’re saving for your child’s education, you may not need that money for 15 more years. When you will need your money will be a major piece of your investment strategy. If you need cash in two years or less, you will want to invest in something safer like a CD so you don’t risk those funds. GOBankingRates.com provides several short term investment options. If you don’t need your money for five years or more, you can afford to take more risk, therefore possibly getting higher returns.
3. What’s your risk tolerance?
Your risk tolerance is how much risk you are willing to take to achieve potentially greater rewards. Financial planners use sophisticated analysis to determine a client’s risk tolerance, and gauging it yourself can be tricky. You may be a rock-climbing, extreme snow boarder in real life, but that doesn’t mean you’re necessarily a risk taking investor. Your risk tolerance level depends on not only your personal attitudes towards risk but also your age, financial security, cash needs, timing and goals. While no online questionnaire can compare to a full risk analysis by a professional, I like the University of Missouri’s quiz. While the results should just be used as a starting point, the questions illustrate all the factors that go into your personal risk tolerance. Risk tolerance matters because it will determine how much money you invest in stocks (risky) versus bonds and other less risky investments. This is called your asset allocation.
4. Determine your appropriate asset allocation
Once you’ve determined your risk tolerance, you can now start thinking about an appropriate asset allocation. Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, mutual funds, bonds and cash. Schwab.com provides several hypothetical asset allocations and the risk associated with each. For example, an aggressive portfolio consisting of 80% stocks would have seen a 10% annualized return between 1970-2014, but a whopping max low of -44%. On the other hand, a conservative portfolio with 30% in stocks saw a smaller return of 8.1%, but the max loss they sustained was only 14%. Going back to your risk tolerance; if just seeing a -44% possible loss makes you queasy, you’ll probably want to take a more conservative route.
Put it all together: You can see that the above four steps are all critical components, with each step building off the other to create your personal investment strategy. Even if you are working with a financial planner, you should be actively involved in creating this strategy because it’s based on your goals and your needs. Your strategy provides the framework to start choosing your investments, and building a smart portfolio. Now the fun begins!
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