The first question many people have when considering to invest is, “What is my return when I invest in this investment?” Naturally before you make an investment, you would want to know if it is worth your time and money to make the investment. The easiest way to do this is to look at the percentage return you would get from investing. But don’t just focus on the returns. You also have to consider if you are personally “ready” to start investing. Here are 5 personal factors you should consider before investing.
The Most Important Factor
One of the biggest mistakes people make is to invest money that they can’t afford to lose. This is a big problem. Because investments are generally risky and your money is normally tied up for a long period of time.
If you invest money that you can’t afford to lose and you don’t have any additional savings, in the event where you suddenly need a large sum of cash, you would be forced to sell your investments to raise the money. And in some cases, you would be forced to sell them at a loss.
So what is the way to solve this? Build up your emergency fund!
Make sure to build up an emergency fund that can cover around 6-8 months of expenses. The idea of an emergency fund is to provide you cash in case of an emergency. With an emergency fund you won’t be forced to sell your investments, and possibly sell them at a loss, if you suddenly need a large sum of cash.
So always remember, build up an emergency fund before you invest. Invest money that you can afford to lose or money where you won’t touch for a long period of time. If you don’t have this kind of money, start saving up now to build up your investing capital.
In additional to having an investment capital, here are 4 additional important factors that you should consider before investing.
1. What Are You Investing For?
Are you investing for any particular expense in mind? Or perhaps you want to ask yourself, “When is the next major event where you would possibly need a large sum of money?”
An example could be making the down payment on a home. Or perhaps it is for your kid’s college tuition fee. Or maybe you are just saving up with retirement in mind. Knowing what you are investing for gives you a clearer picture of how much money you need and how long you have to achieve the goal.
For example if you are saving up for retirement, your goal could be to build up a nest egg of $800k before you are 50. Setting a clear goal makes it easier for you to track your progress and time you have left.
2. How Long Will You Be Investing For?
Knowing the time period you are investing for is crucial. If you have a longer time period to invest, you can choose investments that carry a slightly higher risk. Because you will be less affected by downturns in the market since you can afford to hold onto your investments.
Most investments appreciate in value over time and with a longer time frame, you will have a better chance at weathering any downturns or depression in the economy.
If you have a shorter time frame to invest, such as 1 to 2 years, you might want to consider choosing something that has a lower risk but gives you a better guarantee of your capital.
3. What Is Your Risk Tolerance?
Are you comfortable with your portfolio being down 5%, 10% or even 20%? If this makes you worry a lot and keeps you up at night, it would be a better idea to choose investments that don’t fluctuate so much. However remember that lower risk will lead to lower returns.
If you are looking for high returns on your investment, you need to get more comfortable with their risks. A way to overcome this is to learn about the product you are investing in and how the risk comes about.
4. How Much Time And Effort Will You Put In?
Between working a job, looking after your family and all the other commitments at present, you probably don’t have a lot of time for yourself. How much of this time are you willing to dedicate to learn about investing?
Do you prefer to do all your investing for yourself? Or will you be okay with putting your money with an adviser to carry out the investments on your behalf? Are your expectations realistic?
Choosing a more passive approach to investing will possibly give you lower returns compared to an active approach to investing. However choosing an active approach means you have to spend time and effort to learn how to do your own investments. On top of this, you will be responsible for your own results and good results are not guaranteed.
Compared to passive investing, an active approach would definitely give you much higher returns but you will also subject yourself to the possibility of much high losses at the same time.
I have covered a few important factors you should consider before investing. There are many more factors and it will differ according to your own individual situation. But if you cover these 5 personal areas before you invest, you should give yourself a pretty good start!
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