Investing In The Stock Market

Now here is a can of worms.  You have some money, where should you be keeping it?  How can you preserve and grow your money without putting it in excessively risky investments?  The key to finding the best way to invest your money is to understand three things: your goals, your time horizon, and your tolerance for risk.

Now, that might seem a little simple, but why complicate things?  By understanding where you stand on these three factors, you can find the best way to invest for your specific needs.

Goals and Time Horizon

photo credit: julianlimjl

I put these together since they are very closely connected.  Why are you investing?  Do you want to retire early, save money for college, or are you simply tired of letting your money sit around in your savings account earning next to nothing?  Whatever the case might be, each goal requires a different investment style.

Think about it this way.  If you’re saving for a short term goal, what are you hoping will happen?  Basically, you’re hoping that your money will grow, and that you will able to meet your goal better.  What you certainly *do not* want to happen is for any of your money to be lost.  This tells us that for short term and critical financial goals, choosing low risk investments is the way to go.  Saving up your house down payment is a shorter term goal.  Imagine if you had all your down payment money was in stocks, and the market was down when you wanted to buy.  Your investing didn’t help you at all, only hindered you.  Of course, stocks could also be up during this same time, but why risk it?  Use safer, more stable investment vehicles when saving up for short term goals.
If you’re saving up for retirement when you’re young, being more aggressive is OK.  Say the market is down for 5 years.  So what?  You’re not taking the money out until you’re 65, so why worry about where it is now?  Buying and selling only adds to your transactional costs while investing for retirement.  Unless you have flawless market timing skills (which nobody does), you will want to buy and hold slightly riskier investments for retirement to maximize your returns.

Risk Tolerance

Another issue to consider is your tolerance for risk.  Since you want to be buying and holding your positions, you will need to know how much you can tolerate losing without bailing out on your investments.  One common test is called the sleep test.  Basically, the sleep test is asking yourself if you could sleep at night if your portfolio lost a certain amount of value.  If the answer is yes, your risk level is appropriate.  If not, you will want to make your portfolio is a bit safer.  Lower returns due to cautious investing are better than even lower returns due to bailing from the market.  Besides, anything that causes you to lose sleep probably isn’t worth it.

Conclusions

So, I hope this has helped you find the best approach to investing for your needs.  You will want to research and get a good idea what your goals and risk tolerances are before you start putting cash into the market.  Here, as with most things, a little planning can go a long way.