This five-step process will help you sidestep negative consequences by choosing investments that are appropriate for you.
A key piece of the puzzle in making effective investment decisions is to get to know yourself from an investment perspective. Here is a five-stage process that will help you select investments that are right for you.
■ Determine your goals and objectives. When it comes to investing a particular sum of money, it’s best to start off by determining the ultimate purpose you have in mind for the investment. For example, its purpose may be to provide you a source of income when you retire, or maybe you’ll want to use it to buy a car.
Once you’ve established a goal, you can then attach a time frame to your investment. For example, if you’re a 45-year-old investing for retirement, and you plan to retire at 65, you have an investment time frame of 20 years. On the other hand, if you’re investing to buy a car three years down the road, your time frame is just a few years.
Knowing your goal and the time frame to achieve it will help you make realistic decisions about the appropriate types of investment that will let you reach your objective. If you have 20 years until you need to draw upon your investment, you can afford to accept the higher level of risk that say, equities, entail.
That’s because, though equity markets are volatile, they tend to rise over longer time frames.
If, however, you need your investment to buy a car in three years, the risk that equity markets will be down in that time frame is too great. You’re better off investing in something like a three-year GIC or bond for your goal.
That way, your original investment will be intact when it comes time to purchase your car.
■ Financial circumstances. Your financial circumstances dictate the amount of money you can save to invest and, therefore, the risk you can accept. If, over time, you can save large sums of money, you can afford to take greater risks, and possibly earn higher returns as a result. But in a smaller portfolio such risk might wipe out what little you have managed to accumulate.
■ Personal circumstances. These refer to such factors as marital status, whether you have children or not, or whether you’re a spendthrift or frugal person. Personal circumstances will have an impact on your financial circumstances, and, in turn, the types of investment risk you can assume.
■ Investment knowledge. Knowledgeable investors generally have a better appreciation of investment risk than less sophisticated investors. And that can have a bearing on the suitability of different investment products.
■ Risk tolerance. Knowing what investments are appropriate for you often comes down to your risk tolerance. By risk, we often mean the potential for volatility. Some types of investments are more volatile than others. And some investors don’t have the temperament to withstand high volatility.
This is an edited version of an article that was originally published for subscribers in the March 12, 2021, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846