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Don't Invest Before You Do This

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If your first thought when you have money to invest is what stocks or other investments you're going to buy, then you're going about it all wrong. Instead of putting the cart before the horse, you need to take a step back and ask some basic questions about why you're investing and what you're hoping to get out of your investments at some point in the future.

Don't cut corners
Nearly everything that's worth doing takes a whole lot of effort. For every hour that an athlete or performance artist gets in the limelight, weeks or even months of preparation go toward refining their skills as much as possible.

The same is true for investing. Sure, the fun part for many investors is going ahead and buying that stock or mutual fund and getting your money to work. But if you skimp on all the work and preparation that should come before you write a check or push the buy button on your discount broker's website, then you won't get the results you need -- in large part because you won't even know what you need.

3 steps to better investing
So what exactly do you need to do before you pull the trigger? Here's the short list:

Sounds simple, right? Unfortunately, it can be harder than you think.

Case study: retirement
For instance, consider a goal nearly everyone has: a comfortable retirement. If you have more than 10 years or so to go before you plan to retire, you can generally afford to take an aggressive stance toward your investments. Based on guidelines from the Fool's Rule Your Retirement service and its model portfolios (with some simplifying changes), here's a possible way you could set up your portfolio using exchange-traded funds:

  • 20% in SPDR Trust (NYSE: SPY  ) .
  • 15% in iShares Russell 1000 Value ETF (NYSE: IWD  ) .
  • 15% in SPDR S&P Midcap 400 (NYSE: MDY  ) .
  • 15% in iShares Russell 2000 ETF (NYSE: IWM  ) .
  • 15% in Vanguard Europe Pacific ETF (NYSE: VEA  ) .
  • 10% in Vanguard Emerging Markets Stock ETF (NYSE: VWO  ) .
  • 10% in bonds, including a 5% allocation to iShares Barclays TIPS Bond (NYSE: TIP  ) .

Following a model portfolio is just about the easiest way you can invest. Just set up a brokerage account, buy some funds, and you're done.

But wait a second. By itself, a model portfolio leaves some important questions unanswered. How much do you need to put into this model allocation every month? How much will you have saved by the time you retire, and will that be enough? How will you spend down your retirement nest egg after you quit your job? If you just save whatever you have left at the end of the month in a bunch of ETFs, you'll probably be disappointed when retirement rolls around and it turns out you're not really ready for it financially.

The big picture
Moreover, your financial picture isn't that simple. For instance, you probably need to save for other things beside retirement. If you have shorter-term goals, such as buying a house or putting your teenage kids through college, that long-term model allocation won't work. More importantly, unless you're extremely lucky, you probably don't have the resources to save fully for all your goals.

That's where those pre-investing steps come in handy. Prioritizing your competing goals lets you give each one the attention it deserves. Figuring out when you'll need money to meet those financial needs will let you invest several pockets of money in different ways, letting you achieve early goals without sacrificing progress toward ones that are further into the future.

Sure, picking what to invest in is one of the most interesting things about investing. But it's not the only thing; and in many ways, it's not even the most important. Assessing goals and coming up with basic strategies to get you there may not be glamorous, but it's the key to getting to the finish line successfully. If you take care of business before you invest, you'll be a lot more likely to have the financial life you want.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger never practiced the piano as much as he should have, but he makes up for it with his investing. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of Vanguard Emerging Markets Stock ETF and iShares Barclays TIPS Bond. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy puts things in the right order.


Read/Post Comments (4) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 30, 2010, at 3:27 PM, HectorLemans wrote:

    #1: Pay off all debt except house (if company matches 401k - throw enough at that to get match as well)

    #2: Start investing

  • Report this Comment On July 01, 2010, at 7:59 PM, badnicolez wrote:

    This would be fine advice, but you forgot to mention that peole should never, ever save for college if they don't have retirement fully funded. Kids can get loans for college, there's no such thing as a "retirement loan."

  • Report this Comment On July 02, 2010, at 3:47 PM, wolfman225 wrote:

    You forgot taking the step of setting up an emergency fund to cover current expenses for a set amout of time (I'm using 6 months). I've managed that.

    However, after using several different retirement calculators to figure the required size of my nest egg, the average amount I have targeted is $1.25M at age 67. That's <i>without</i> buying a house. Since I've just gone through a divorce, I've got almost no other savings left after clearing debt and setting up my emergency fund. My average income is $45K. Given this, I calculate that I will need to realize at least 18% annualized returns over the next 20 years to reach my retirement. That, or resign myself to working into my 70's.

    Dan, do you have any "model portfolios" up your sleeve that will come close to that figure?

  • Report this Comment On July 05, 2010, at 10:32 AM, neamakri wrote:

    ~~ 401K ~~

    (1) Put the maximum possible in here. It is pre-tax, so you get a lot more bang for your buck. Also, if you don't see the money you won't miss it. If you are old enough you can play "catch up" and put in a higher amount.

    (2) Assuming you have choices in your 401K, check each choice for "holdings". Investigate the holdings to assure yourself you want to own that choice. I put 50/50 into only two choices in my 401K because they are the best two choices.

    (3) Don't chase the "18% return"; you will get burned. Instead just do the best you can with your resources. I have an IRA account that is invested in ALL dividend payers. You might start investing with at&t (T) and new york bank (NYB).

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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