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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:
- Prioritize all the financial needs and wants you have.
- Figure out when you'll need your money back, and how much you need it to grow between now and then.
- Choose investments that fit your needs and work with your timeframe and resources.
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.