Preparing to Invest

5. Choose Investments Wisely

 

Once you’ve identified your goals, estimated their cost, and determined when you’ll need the money, it’s time to decide which combination of savings accounts and investments is appropriate for you. Part of this challenge is that most people plan and invest for a variety of goals—some short term, some mid term, and some long term—all at the same time. One possible solution to this dilemma is to consider establishing a separate account for each goal to make it easier to select and manage your investments. That way, you can treat the money you’re saving for a down payment on a home differently from the contributions you make to an individual retirement account (IRA) or a college savings fund..

If you work with an investment professional to set your goals and take steps to reach them, he or she should be able to help you identify the types of investments that are most appropriate for different time frames. An experienced investment professional ought to know the spectrum of alternatives that are available to you, how different investment choices work, and the risks and returns you should be prepared for if you choose a particular investment. But ultimately you will need to know what you own and why.  You cannot make an informed choice about an investment without asking probing questions about its features, risks, and costs—and you should not invest in something you don’t understand, no matter who recommends it to you.

If you take the lead yourself, you should be prepared to spend time learning about various investments and the markets in which you buy and sell them.  You should think about whether the investments you’re considering are or are not appropriate at this point in your life. The more you know about your investment choices, the more likely it is you’ll make decisions that are right for you. 

Regardless of whether you select investments on your own or seek professional advice, you should be aware that you pay fees and expenses with virtually all financial products and services. Those costs, which reduce your investments’ returns, are generally documented — for example, in a required disclosure document, such as a mutual fund prospectus, or in a brokerage firm’s schedule of fees and commissions. It’s important to find out what those costs are and compare the total expense with the expected returns, as well as the costs of other, similar investments.

Keeping an Eye on the Big Picture

Setting investment goals and making investment choices is just the beginning. You’ll also want to learn as much as you can about how to evaluate potential investments and keep track of the progress you’re making toward accumulating the money you need to reach your objectives. That doesn’t necessarily require checking your account every day, but it does mean that you should keep an eye on whether the value of your portfolio is increasing from month to month and year to year.  It often pays to take a long-term perspective on investing and not be too hasty to switch investments based on short-term results.   

But if your investments aren’t delivering the results you had anticipated over a period of time, especially if the financial markets as a whole are doing well, you should be prepared to seek alternatives.

You’ll also want to keep in mind the passage of time. What you initially considered to be long-term goals can become mid-term and short-term goals very quickly. That requires rethinking how your money is invested and whether you should begin to make some changes.

In addition, while some goals are flexible and can be postponed, others have specific dates. For example, many students begin college at 17 or 18, and need money for tuition at that point, not several years in the future. Other goals are more flexible. You can often wait to buy a home or postpone retiring from your job if that extra time will make it more affordable.

You also have to be prepared for surprises. For example, many people retire earlier than they had planned because their employer downsizes or a company closes its doors.

6. Practice Good Habits

 

Good habits pay off in many areas of life, and practicing good savings and investing habits is no exception.  Sometimes, a single action can create a continuing habit.  For example, if you contribute as much as possible to an employer sponsored retirement plan where you work—or if you have money transferred directly each month from your checking account to one or more savings and investment accounts—then you’ve established the habit of paying yourself automatically. Not only does that eliminate the risk that you will forget to save or invest regularly, but you also might find that you never miss that money because it comes out of your paycheck before you can spend it. In fact, you might ultimately decide it makes sense to do the bulk of your saving and investing this way.

Remember, too, that if you spend the money in a tax-deferred retirement account—such as an individual retirement account (IRA) or employer-sponsored 401(k) or similar plan—before you reach age 59 ½, you will owe taxes and probably penalties. That’s an added incentive not to touch the money even when you might be able to withdraw it.

You should also consider:

1. Reinvesting all the interest, dividends, or distributions you earn on your existing investments, which happens automatically with tax-deferred accounts
2. Earmarking a percentage of all gifts, bonuses, and unexpected income to your investment accounts
3. Paying your credit card bills in full each month and investing the money you had been spending on finance charges
4. Budgeting a specific percentage of your income for investing
5. Making sure that the amount your employer withholds for taxes is neither too much nor too little—the average refund is more than $2,000—and put the difference in your investment account throughout the year.

 

It’s often wise to open a special account to hold the money you are accumulating specifically to buy investments. That might be a money market mutual fund or other cash account with your brokerage firm so that you can easily transfer the money needed to pay for the purchase of a stock, bond, mutual fund, or other investment. Similarly, proceeds from investments you sell and any dividends or interest from investments you’ve already made can be rolled into that account, where they will be available to cover new purchases.

If you invest directly with a mutual fund company, you can set up a similar arrangement.  You might use the fund company’s money market fund to hold your cash, and then transfer it into a stock, bond, or other mutual fund when you have enough cash to meet any investment minimum. Once you’ve purchased a money market fund with the mutual fund company, you can then arrange for a regular direct deposit from your paycheck—or an automatic transfer from a bank account—to your account. The amount required for additional deposits is almost always less than the minimum to purchase a fund.

Whether you open an account at a brokerage firm or with a mutual fund company or both, be sure to ask about any account maintenance and transaction fees that may apply.

Finally, it is important to check your account statements—from every bank, brokerage firm, mutual fund company, or other financial institution you do business with—to confirm that all of your transactions are accurately reflected.  If you detect an error, be sure to contact your financial institution right away.  And, for your investments, be sure to monitor your portfolio performance on a regular basis to make sure that you maximize your returns over time.