“Can’t someone just pick my investments for me?”
That’s one of the most common questions I receive about investing. I get it: investing can be confusing! Outside of learning all of the different types of investments (like stocks, bonds, and real assets), there are so many different ways to pair them together (such as a mutual fund or target date fund). It can be challenging to know what’s right for you.
While a professional can certainly help you to pick the right investments and, in some cases, even pick them for you, they are still going to need some information from you: What’s your goal? Are you saving for retirement, your child’s education, or something else entirely? How many years until you will need the money? How much do you think you will need? How much are you starting with? Even if you don’t have specific answers, you’ll want to give these questions some thought before you seek professional guidance.
And, let’s not forget one more key piece of information: your risk tolerance. How much are you willing to risk to allow your investments to grow? If you’re not quite sure, keep these things in mind:
Investing is like an amusement park ride: Whether you are investing in bonds, individual small stocks, or an index fund, you’re going on a ride. Some are like the merry-go round, where you are secure in your seat gliding gently up and down. Others are like a rickety old wooden roller coaster, soaring to high heights and then taking nose dives leaving you both thrilled and fearing for your life. Either way you go, there will be ups (higher returns) and downs (lower returns and/or losses) — but they are a very different ride.
Tip: Remember no matter what you invest in, ups AND downs will be a part of the ride. There are no rides that only go up. There is no risk-free investment. Even keeping your money in a savings account is not free of risk because your measly interest earnings aren’t likely to keep up the pace with inflation (the rise in costs of goods and services over time, generally averaging 3.22% per year).
Look into the risks and rewards: Often when people are selecting their risk tolerance, they go back to a time in their life when they felt most risk averse. For instance, I used to base my investment decisions on my experience with the Great Recession, when I and people I cared about lost about half of their stock market savings. I never wanted to feel like my hard-earned money had been squandered, so I was very conservative. What I didn’t know then was that during the next ten years following the recession the market (on average) would more than earn back what was lost.
Tip: Make sure to ask yourself not only how much you’re willing to lose but also how much you are willing to gain. It’s important to evaluate both the positives and the negatives when you make your decision.
Risk tolerance should be constant no matter the market conditions: When stocks are on the rise, people are more likely to take a little more risk. However, when things begin to tank, people generally panic and begin to make rash changes. Remember, the key with investing is to buy low and sell high — this is how money is made. Buying high (when stocks are on the rise) and selling low (when things have tanked) is a great way to lose money. Work to find a balanced approach that you can stick to no matter the season of the market.
Tip: One of the best ways to find a balanced approach is to use diversification. Instead of investing in individual stocks, industries, companies, or investment types, buy a slice of the market that represents a variety. This may sound complicated, but you can do this fairly easily by investing in mutual funds, target date funds, or index funds.
Your investment mix may change based on your goal and your timeline: While your risk tolerance remains the same no matter what goal you are saving for, the investment mix that you choose will vary based on a few other factors — namely your timeline to reach the goal and the type of goal you’re looking to achieve. For instance, you likely have a longer time horizon with a retirement account, so you can afford to take more risk. Whereas with an emergency fund, since you don’t know exactly when you might need the money you’ll want to take less risk no matter your risk tolerance.
Tip: While it may be tempting to “set it and forget it” when it comes to investing, especially when you have a longer time horizon to reach your goal, it’s important to check in with your investments at least annually to make sure you are on the right track. Even if you are investing aggressively at the beginning, you’ll likely want to taper off that risk as you get closer to your goal so you can easily access the money when you need it. If you don’t do this with a goal with a longer time horizon (like saving up for your child’s education), it’s possible you may have too much risk exposure when your child reaches age 18 and may even lose the money you worked so hard to save if the market tanks and there’s not have enough time to earn it back.
Check out this Nerdwallet article to find out more about risk tolerance and take their risk tolerance quiz. In this month’s date night club we are diving even deeper into investing by taking a closer look at your and your partner’s investment style. Join today!
Grace Pomroy provides general information about investing for educational purposes only. This article is not advice about specific investments or investment strategies.