We have all heard of the seven deadly sins, things that you should never do or you risk the harshest of punishments. But many people don’t know about the seven deadly questions, involving your investments. There are seven questions that one must answer before beginning to have peace of mind with your investments. Making investment decisions isn’t easy, especially if you are just entering the game. There are a lot of details that many people don’t think about until it’s too late. So, if you want to avoid the life long pain of poor investment plans, ask yourself these seven questions.
1. “Why?” It’s a simple question, but it’s often the hardest one to answer. Why are you investing, and what do you hope to gain from it? In other words, you must set specific goals. Maybe you want to save for retirement, maybe you want to send your kids to college, or maybe you just want some breathing room from everyday expenses. Whatever the reason, it’s important that you define why you investing your money and what goals you wish to accomplish in doing so. This will help you to decide how much money to put away.
2. “What is my time frame?” This is like asking, how long will it be until I need the money? This can depend on your age, and of course your answer to question number one. If you are putting money away for retirement, your time frame should not end at the day you plan to retire, it should end at the day you plan to die. You will need that money at the beginning of retirement, but you will keep it invested throughout retirement if you do it right.
3. “What am I going to get out of it?” What can you realistically expect to earn on your investments? Having an unrealistic idea of playing the stock market and striking it rich could leave you simply striking out. Investing in stocks is not the problem, it is the expectation of beating the market, rather than expecting to get market returns. Other investments, such as bonds, have fixed returns that are not as susceptible to market changes but have a lower expected return.
4. “What kind of earnings will you make?” Very few times when investing does a wad of cash appear in your mailbox if you’re successful. Your earnings will be very inconsistent in the short term, so there is no point in fretting over 1, 3, or 5 year returns. The annual return that you will get is dependent on the type of investment you are in. Which leads me to my next point.
5. “What’s my risk?” And here comes the basic balance in investing, risk versus reward. The higher the risk, usually the higher the potential reward, but that is not always the case. Overall there is no guarantee that you will get your money back or receive the earnings promised to you, unless you have your money in a savings account or a U.S. Treasury security, both of which are backed by the federal government and give you extremely small returns. Make sure that the risk you take is worth the reward that you expect to achieve. If you have a longer time frame, you can invest in riskier investments.
6. “Is my money diversified?” We can all remember our mothers at some point or another saying, “Now, don’t put all your eggs in one basket.” Well your mother’s wise words ring true in terms of investments as well. Certain types of investments do better in certain situations, so by diversifying your investments, you are spreading your eggs across many baskets. That way if a certain industry tanks or sector is struggling, you will have plenty of other baskets holding your money safe and sound. This doesn’t mean having different accounts or different advisors, but having different holdings in thousands of stocks and bonds.
7. “What is the effect of taxes on my investments?” Every person who receives any earned income can invest in a tax advantaged plan. Whether that be a 401k or 403B at work, or an IRA/Roth IRA, or all of the above. Make sure you understand the implications of how your money is taxed with each type of account. In many cases, a Roth IRA is the best for your tax situation, especially in retirement. Also, make sure you plan to have enough money saved to pay for taxes in retirement.
By Jimmy Hancock