Before investing any money in stocks, bonds, mutual funds, exchange traded funds (ETFs), etc. you should determine and/or know your investment risk tolerance.
Your investment risk tolerance will change as you get older and closer to retirement.
The younger you are the more risk you can afford to take, within reason of course, because you have TIME on your side.
Having a twenty, thirty or forty year investment time horizon is much better than having a five, ten or fifteen year time investment horizon.
First things first – having an emergency fund
Before you even start researching investments you should have a six to nine month emergency fund.
The last thing that you want to do is to put most or all of your life savings into an investment thinking you will make lots of money with this investment only to have it drop in value and you have an emergency such as your car breaks down, you get sick and go to the hospital, lose your job, etc. and have to sell your investment at a loss.
Having an emergency fund will help you get back on your feet and lessen the likelihood of needing to sell some or all of your investments.
What is your investment objective
Determining your investment objective is important so you can determine the proper types of investments.
Some investment objectives are:
- safety of principle
- growth and income
- stock options, bitcoin, commodities
what is your investment time horizon
When you have money to invest and you are in your twenties and thirties you have a long term time horizon. Thirty to forty years to ride it out if an investment(s) should go south.
With a long term time horizon your risk tolerance is likely to be higher than a person fifty years old simply because their investment time horizon is about half of yours.
Determine your investment risk tolerance
When doing financial planning you need to take into account your investment risk tolerance. The potential for greater returns comes with greater risk.
Investments with higher potential returns come with higher risk of loss on your investment. You simply can not have a potential for a high return on your investment without also having a high risk of loss.
As an investor which of these risk levels are you comfortable with?
If you are looking for low risk investments you would not be looking to invest money in the stock or bond markets.
The risk factor is too high for you to own stocks, bonds, mutual funds or ETFs because you would likely sell your investment(s) the first time the market takes a dip.
Instead you would want to look into money market accounts and Certificates of Deposit (CDs). You may also want to consider investing in U.S. Treasury securities.
If you do not belong to a credit union I highly recommend joining one in your area. I have been a member of a military credit union since the mid seventies.
Credit unions are likely to treat you better than a bank. They will likely have better loan rates and lower fees on their products and services. You may also be able to earn a higher interest rate on your money than you can from a bank.
Paying a lower interest rate on loans you obtain from a credit union instead of a bank loan keeps more money in your pocket.
Investors with a moderate risk tolerance would be suited for mutual fund and exchange traded fund (ETFs) investments.
High risk tolerance investors would feel comfortable investing in stock options and individual stocks and bonds.
Investment risk tolerance can also be classified as aggressive, moderate or conservative. It is basically saying the same thing as low, moderate and high risk.
You must understand what you are investing in before you invest
If you can not or do not understand what it is that you want to invest your money in then you should not be making that investment.
Yes, it may be a mutual fund or an ETF, but if you don’t understand the objective and the risks of the investments you are interested in investing your money in, don’t invest in them.
Not all mutual funds and ETFs are the same. Each one is different in some particular way. It is up to you to know and understand the risks a fund has as well as the objective of the security.
Check on my blog post on conducting research before investing.
Understanding the Rule of 72
Basically, the rule of 72 is used to determine the amount of time it will take your money to double based on the money earning a certain interest rate.
Simply take the rate of return on your money and divide it into 72. That will tell you the number of years it will take for your money to double assuming your money will always earn that rate of return.
For example, if you can earn a fixed 7.2% annual rate of return on your money, your money will double in 10 years.
72 divided by 7.2 = 10.
You have to be aware of inflation and how it decreases your purchasing power over time.
A dollar does not have the same purchasing power it had five, ten or twenty years ago.
Inflation can erode your investment return. For example, if your investment risk tolerance is low and you invest in fixed assets that have a 3% return and if inflation is 3 1/2% you are losing money on your investments.
Yes, you have safety in your investments but that may not be enough to keep you ahead of inflation.
I hope the information provided on this blog post and my entire blog will help you to make better investment decisions.
Remember, you need to be realistic when determining your risk tolerance. If the market drops and you sell instead of holding on to your investments you could end up taking a loss.
It is important to have the right risk tolerance as you approach retirement. Being 100% invested in stocks may not be a wise idea when you are only five to seven years away from retirement.
Please do not take any information I have provided on this blog post or anywhere on this blog as investment advice because it is not.
I may be getting a Series 65 securities license which will allow me to provide investment recommendations to individuals, but I don’t have a securities license right now.
The Series 65 license will not allow me to sell any type of securities, I would need to obtain a Series 6 or Series 7 securities license in addition to a Series 65 license. That is not something I am considering right now.
P.S. If you think your friends would find this information beneficial, please share it with them. Thank you.