People ask me all the time if they should be putting some money into mutual funds, individual stocks, bonds, and so forth. Generally, I just ask them a few very simple questions and then give a simple answer that will set them down a path appropriate for their goals. Let’s walk through these questions and see where they lead you.
What is my goal with this money? If you’re thinking of investing money, you must have a vision for what you want to do with it. Do you want to buy your dream home in twenty years? Do you want to retire in five years? Do you want to quit your job in one year? Try to define a specific goal for the savings and also an approximate timeframe for that goal.
How far off is that goal? I generally sort people into three groups based on how far off the goal is: longer than ten years, one to ten years, and one year or less. If your goal is less than ten years, a mutual fund (especially one based in stocks) is probably not the best place to put the cash. If your goal is less than one year, I would actually leave it in cash and put it in a high-yield savings account.
Are you willing to devote a lot of regular time to your investment? For almost everyone, the answer is no, and if that’s the case mutual funds are probably the place to put your long term money. They take much of the time out of direct portfolio management.
As a general rule of thumb, the farther off your goals are, the riskier the mutual fund can be. If you’re looking at a forty year goal, having your money in things like an international small cap fund might be worthwhile because that fund could contain the next Microsoft, Cisco, and Google, but also might hold a Boo.com or two. However, if your goal is much closer (say, fifteen years), you probably want your cash in a relatively safe fund, like the Vanguard Total Market Index.