Investing For Your Future
Monthly IFYF Investment Message
November 2004
Five Steps For Beginning Investors
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Are you just getting started as an investor? Or have you been investing for a while but honestly don't know what you're doing? If so, this month's Investing For Your Future message is especially for you. It describes five basic steps that all investors should follow to increase the odds of a successful outcome (read: making money and avoiding a loss of principal).
Step #1 is to set specific financial goals with a date and a dollar cost. They don't have to be complicated but, rather, simple statements of what you want to accomplish such as "Buy a late model used car in 2007 for $10,000" or "Pay an extra $50 month toward credit card debt for the next two years." Your goal statements will help narrow down your investment choices. For example, if your goal is five or more years away, you will probably want to select growth oriented investments such as stocks and stock mutual funds. Be as specific as you possibly can with your financial goals and consult references (e.g., car-buying reports), if necessary, to get the information needed to describe them.
Step #2 is to do some math to determine how much you need to invest periodically to reach your goals. Many mutual fund companies and personal finance magazines such as Money, Smart Money, and Kiplinger's Personal Finance have interactive calculators on their Web sites that you can use. The calculators will ask you to put in the amount you have available to invest (lump sum or periodic deposits), your estimated average annual return, and the number of years you have available to reach your goal. If your first estimate is off, simply keep reworking the key variables until you find a savings amount that you can afford.
Step #3 is to take some type of risk tolerance evaluation such as the one found on the Rutgers Cooperative Extension Web site at http://www.rce.rutgers.edu/money/riskquiz. Like goal statements, your risk tolerance profile will help you narrow your options. You will need to evaluate honestly if you're a conservative, moderate, or aggressive investor. These quizzes will ask you about risks that you take in other areas of life besides finances and questions such as "How much can you stand to lose on an investment before you start to lose sleep at night: 5%, 10%, or 20%?
Step #4 is to become familiar with the three major classifications of investments: stocks, bonds, and cash. When you buy stock, you have ownership in a company. The primary goal of owning a stock is long-term growth. There are also different classifications of stock, such as large, established companies called "Blue Chip" stocks, small companies, and international companies. When you have bonds in your portfolio, you become a lender. You're lending a company or government entity your money with the promise that they'll return your principal and pay periodic interest. Cash assets include certificates of deposit (CDs) and money market funds. They are a great place to hold emergency funds and to "park" your money between investment decisions. The downside of cash assets is that they provide no opportunity for growth and often don't keep pace with inflation.
Step #5 is to automate your investment transactions. One of the basic investment principles discussed in Unit 2 of Investing For Your Future is dollar-cost averaging. This is the process of investing a regular sum (e.g., $100) at a regular time interval (e.g., monthly), such as the deposits many workers make to a 401(k) or 403(b) plan. By investing in a regular, consistent pattern, you average the highs and lows of the market and keep emotions (e.g., reacting to market losses) out of investment decisions. Many investments, such as mutual funds and stocks that are offered in dividend reinvestment plans (DRIPs) make it easy to automate investment deposits. Simply provide the dollar amount, day of the month, and bank account to be debited and transactions will take place on schedule.