Why are you investing? It's OK if you have many different answers for 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 are not working toward a goal and monitoring your progress. In this article, we examine some common reasons for investing and suggest investments that fit those reasons.
No one knows whether the pension system will survive the coming decades. It is this uncertainty and the reality of inflation that force us to plan for our own retirement. You need only open the newspaper to find out about a company that is freezing pensions or 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:
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 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? Want to go on a cruise from Seattle to Morocco? Wouldn't a vacation that was paid for with dividends feel nicer?
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 in total 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. It can be done, but it is much easier to find good returns on investment without having to fight losses on your debt.
There are different kinds of debt - credit card, mortgage, student loans, loan sharks - and they carry different degrees of weight when you are considering whether to invest in spite of them.
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. Returning to the exercise analogy, you don't walk into a gym and squat 500 pounds your first day (unless having kneecaps bothers you). 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 other option 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.