If you want to build wealth, you need to invest.
But while the actual act of investing is relatively straightforward and quick, the decision-making around investing takes some time and careful consideration. That includes determining whether you’re actually ready to invest—and if so, how you’re going to go about doing it.
Today, I’ve cooked up 10 questions you should ask yourself before you start investing. While there is no guarantee of success when you invest, answering these questions will help you start out on much better footing, and with clearer purpose.
Let’s get started.
Make These Decisions Before You Start Investing
Maybe you’ve heard too many stories about your friends getting rich in the stock market. Maybe you saw a “hot tip” on social media or on a website.
However, no matter how immediate your desire to invest feels, the beginning of your stock journey will go more smoothly if you start in a calm, mentally organized fashion.
Put differently: Don’t just start throwing your money at an investment on a whim.
If you have the itch and you’re thinking about getting started, run through the following set of questions. The answers will help you determine how you take your important first few steps.
1. What Are My Investment Goals?
You’re unlikely to get into a car or on a plane without a destination in mind, and you should treat investing the same way. That’s because knowing your destination allows you to plan the most optimized route.
Investing for retirement is one of the most common goals, but people invest toward a wide variety of other aims: a down payment on a house, your children’s education, even a vacation.
Once you determine your goals, you’ll want to divvy them up into buckets. One helpful way to look at them is …
- Short-term goals: One to three years
- Medium-term goals: Three to 10 years
- Long-term goals: Longer than 10 years
Why separate goals like this? Because the time frame affects what types of investments are most appropriate.
For instance, high-risk stocks can help deliver the growth you need to reach your long-term retirement goals. But they also tend to be very volatile and go up or down a lot in the short term—and if you need money within the next year, you might want to avoid investments that could drop significantly in the short term.
Conversely, if you plan to buy a house within a year, you could consider putting your money in a 12-month CD, which will earn some interest and free up your funds by the time you’re ready to buy. However, CDs don’t have nearly the growth potential of stocks, so they might not be a great way to reach your retirement savings goals.
Related: 15 Best Investing Research & Stock Analysis Websites
2. What Is My Risk Tolerance?
Virtually every investment involves some amount of risk, but some investments are far riskier than others.
Risk tolerance, as explained by the Financial Industry Regulatory Authority (FINRA), is a person’s “willingness to lose some or all of [the] original investment in exchange for greater potential returns.”
While the stock market isn’t a casino, it’s easy to explain risk with gambling. Consider a roulette wheel: Choosing red or black correctly is much likelier, but provides less reward, than choosing double zero; choosing double zero correctly is extremely unlikely, but it provides much more reward than choosing red or black.
When you invest, it is generally (though not always) true that the higher the risk you accept, the higher the potential returns.
Like with time horizon, risk tolerance has a massive impact on the types of investments that are right for you. It also goes hand in hand with your investment goals—generally, the farther away your goals, the riskier you can afford to be, as you have more time to recover from dips in your portfolio’s worth.
Those with extremely low risk tolerance might gravitate toward safer investments such as money market funds, certificates of deposit, and money market funds. Those with a little more appetite might venture into bonds, or maybe blue-chip stocks. Growth stocks might befit someone with quite a bit of risk tolerance. And alternative investments ranging from cryptocurrency to shoes might be right for someone who is willing to lose a lot to gain a lot.
Related: How to Invest Money: 5 Steps to Start Investing w/Little Money
3. Am I Investing for Growth or Income?
There are two primary ways an investment can earn you money:
- Capital gains (growth): You buy something. That something grows in value. You sell it for a profit. (Example: You a buy a stock for $50. After five years, you sell the stock for $100. You earn $50.)
- Income: You buy something. That something pays you a dividend or interest while you hold it. (Example: You buy a $1,000 bond with a 5% coupon rate. It pays you $250 twice a year.)
The returns from capital gains generally tend to be higher than the returns from income, and thus capital gains tend to be emphasized earlier in life when you’re growing your nest egg. Income returns are typically lower, but less volatile and more dependable, than capital gains, and thus income tends to be emphasized later in life when the goal is preserving your nest egg.
You don’t necessarily have to choose between growth or income—your investment strategy might (and likely will!) combine both methods. Indeed, some investments provide elements of both!
One last note: Don’t confuse growth vs. income with growth vs. value. The former involves the difference between capital gains and income. The latter involves the difference between two investment strategies—investing in companies expected to grow at an above-average rate (sometimes regardless of value) vs. investing in companies whose shares are value-priced (sometimes regardless of their growth prospects).
Related: 5 Best Money Market Funds [Protect Your Savings]
4. How Much Will I Invest?
To answer the question “How much will I invest?” you have to answer a pair of other questions:
- How much should I invest?
- How much can I afford to invest?
A general recommendation for how much you should invest is at least 15% of your pretax income (including any employer contributions). As you make more money, you should invest proportionally more. And in addition to retirement planning, you should be building an emergency fund and saving for short- and medium-term investing goals.
Another consideration? High-interest debt. Most investments don’t grow any faster than an average annual rate of more than 10%. So if you have any debt that charges interest higher than 10%, mathematically, you’re better off paying down that debt before you make any contributions to retirement accounts (except whatever you need to max out your employer match, which is effectively free money).
As for how much you can afford to invest? The general guidance there is not to invest any more than you can afford to lose. If you have no money left over after meeting all of your needs, you shouldn’t sacrifice those needs just to invest. However, if you make a lot of discretionary purchases, you might consider paring those back to free up money for investing.
By the way: If you’ve already built up an appropriate amount of emergency savings, even if you only have $10 a month left over after meeting your basic needs, you can still put that to work. Fractional share brokerages allow you to buy pieces of stock for $10, $5, sometimes as little as $1.
Related: 7 Best Stock Recommendation Services [Stock Tips + Picks]
5. Where Will I Invest?
“Where will I invest” is also a two-question question:
- What kind of account will I use to invest?
- What provider will I get that account from?
When it comes to the type of account you use to invest, you can look to our guide about maximizing your 401(k) and other accounts. But in brief: There’s something of a hierarchy for which accounts, in which situations, you should invest in based on the ability to get the most out of your money, as well as how much money you have to invest.
For instance, if you’re saving for retirement, you’ll want to start with your 401(k) if you have an employer match, as you’ll enjoy both tax savings (401(k) contributions are tax-deferred) and free money from your employer. However, depending on how close you are to hitting contribution limits, you’ll move on to other tax-advantaged accounts, such as health savings accounts (HSAs) and individual retirement accounts (IRAs), and eventually to taxable brokerage accounts.
But if you are investing for other goals that you need to reach before retirement, 401(k)s and IRAs, which penalize early withdrawals, aren’t ideal. Instead, you might want to start by investing in a taxable brokerage account, or even a high-yield savings account or CD.
As for providers, we can help. Our website has lists of brokers for a variety of accounts, from Roth IRAs and HSAs to investment apps and day trading platforms.
Related: 10 Best 401(k) Alternatives [If You Can’t Get One Through Work]
6. How Will I Diversify?
Have you ever heard the old adage “Don’t put all your eggs in one basket?” Well, that’s the core of the idea of diversification—owning differentiated investments so if one basket falls, you don’t lose all of your eggs.
In short: Diversification protects your wealth. And there are numerous types you should be aware of:
- Quantity diversification: If you have a pot of money, the greater the number of investments you buy with that money, the less impact on your portfolio any one of those investments will have. If you put $10,000 in one stock and it goes to zero, you lose $10,000. If you have $10,000 spread across 100 stocks, and one of those stocks goes to zero, you only lose $100.
- Asset diversification: Owning multiple types of differentiated assets, such as owning stocks, bonds, and precious metals.
- Style diversification: Owning investments across multiple investing styles, such as growth and value, or quality and momentum.
- Sector diversification: Owning investments that belong to different areas of the market, such as utilities, technology companies, and financial firms.
- Geographic diversification: Owning investments that are headquartered/do business in different parts of the world.
As it pertains to the most common investments—stocks and bonds—you can achieve all of the above with investments in individual securities. But doing that can get awfully complicated and expensive. However, investment funds—which include mutual funds, exchange-traded funds (ETFs), and closed-end funds (CEFs), among others—help you own hundreds or even thousands of stocks, bonds, and other investments with a single click and at a much more affordable price.
Related: Best Free Portfolio Trackers + Portfolio Management Software
7. When Will I Invest?
Investing great Ken Fisher has said that “time in the market beats timing the market.” In other words, you’ll have more success investing your money as soon as possible than you will holding your money back hoping for a perfect moment to start putting it to work.
Practically, what does that look like? Let’s say you have a Roth IRA and plan to max it out every year. One good strategy would be to put a lump sum of money (that’s the amount of the annual IRA contribution cap) in your account at the beginning of the year, then invest it all right away. That gives all the money you can contribute the most time possible to grow in this tax-exempt account.
But you might not have that lump sum available at the start of the year. That’s OK! Another proven strategy is dollar-cost averaging (DCA). With DCA, you invest fixed amounts of money at regular intervals regardless of an investment’s price. And it has two benefits:
- It ensures emotions and hunches don’t get in the way of putting your money to work.
- It can result in buying more shares when a stock, bond, or fund is cheap, and fewer shares when it’s expensive. (This helps keep down the average cost of shares you purchase.)
Even expert investors can easily mistime the market or misprice an investment. DCA can help investors sidestep both of these problems.
Related: 15 Best High-Yield Investments [Safe Options Right Now]
8. How Will My Investments Affect My Taxes?
If your investments earn you a profit, the Internal Revenue Service (IRS) will want its cut. And if you didn’t plan for this by putting aside the right amount of money, you could face a nasty surprise the next time you file your taxes.
If you invest in a tax-advantaged account, such as a 401(k) or IRA, your investments themselves won’t result in any specific taxes while you buy or sell within the account. Instead, you’ll simply face any tax consequences when you withdraw funds.
However, if you invest in a taxable brokerage account, or if you have other investments such as real estate or crypto, you’ll need to understand the various ways investments are taxed.
For instance, if you buy a stock and sell it for a higher price later, you’ll face capital gains taxes. If you held that stock for one year or less, you’d be taxed at short-term capital gains rates, which are the same as your federal tax bracket. If you held it for more than one year, you’d be taxed at more favorable long-term capital gains rates, which are either 0%, 15%, or 20%, depending on your taxable income. (By the way, you can also rack up capital losses if your investment loses value—and you can even turn that to your advantage using tax-loss harvesting.)
Dividends are taxed as well. They can be classified as either ordinary or qualified. As the name implies, ordinary dividends are taxed as ordinary income. Meanwhile, qualified dividends that meet specific requirements are taxed at the more favorable capital gains rates.
Related: 19 Best Income-Generating Assets [Invest in Cash Flow]
9. How Liquid Do I Need My Money to Be?
When someone talks about “liquidity,” they mean how accessible money is. Money that you can basically get right away—like funds in your checking account—are extremely liquid. Money that has to remain in a real estate investment for three years before it can be withdrawn is extremely illiquid.
So when you invest, you need to consider how liquid you need certain funds to be.
Any money that you put away for your retirement in tax-advantaged accounts is going to be very illiquid. That’s because if you withdraw money from 401(k)s, IRAs, and similar accounts before you reach age 59½, you’ll likely face taxes and a penalty. Can you access that money? Sure. But you’ll also pay a hefty price.
And if you’re investing toward short-term goals, you’ll want your money to be very liquid. A high-yield savings account or money market account can actually earn you some money while providing fairly easy access to your funds. Same with a taxable brokerage account, though you’ll have to deal with any tax consequences.
Related: 10 Investments that Earn a Great Return [10% or More]
10. Should I Work With a Financial Advisor?
If after all of these questions, you’re feeling a little overwhelmed, it might be time to ask yourself, “Should I work with a financial advisor?“
Financial professionals get to the root of all of the questions above, then use those answers to choose investments that are best suited for their clients.
Not everyone needs a financial advisor right away. If you have very little money to work with, or you have very few financial needs, you might not need one yet. But if you’re starting to deal with larger sums, or your personal financial situation is becoming more complicated, a consultation might make sense for you.
Related: How to Choose a Financial Advisor
