… you might make some general progress, but when you finally come close to the target, it will be very difficult for you to hit that shot.
Time and time again, people write to me and ask questions about how they should be investing their money. “I have $5,000 in savings – how should I invest it?” My response is always the same: “What’s your goal?”
Obviously, there’s no guide in the world that will tell you the perfect investment for what you intend to do, nor is there an easy tool that will help you spell out what your goal is. Over the last few years, though, I’ve learned enough about the basics of investing to recognize that there are a few simple rules of thumb that can help guide you to a rough idea of your goal – and a rough idea of how to get there.
First thing – envision the life you want in five years. Do the same for ten years and twenty years down the road. Flesh out each of these visions with as much detail as you can. What do you hope to accomplish? Are you married? Do you have children? What sort of job do you have? What sort of home do you have?
There is no right or wrong answer. The only answer that matters is what you want.
Once you’ve started fleshing out those pictures of the future, you’ll find that a few elements really excite you. Maybe it’s the job you want. Maybe it’s getting married. It might be children, or it might be a house. Maybe it’s the business or career you’ve launched.
Whatever those key things are that really get your motor running are the very things that you should set as your goals. Plus, since you’re envisioning time frames to begin with, you also have a good sense of roughly how long it should take to get there.
Now, how should you invest for that goal?
If the goal is five years or less down the road, stick with something low risk, like CDs or cash or bonds. Over this short of a timeframe, putting money in market-driven assets like stocks and real estate is basically gambling.
If the goal is ten years or more down the road, consider putting a large portion of it in some market-based assets, like stocks or real estate (or even gold, if that’s a personal philosophy of yours). Over a longer time, the short-term risks of such investments is reduced without losing the potential gains.
If your goal is in the middle, put most of your money somewhere safe and perhaps dabble a bit in a market-based investment, moving your money out after a few years.
As always, don’t overload your risk tolerance. If the thought of losing 40% of your money in a year – even if the general trend is upward over a long period – makes you sick to your stomach, don’t invest in stocks or other market-based investments. If such things make you nervous, you’re very likely to make an irrational move at the wrong time and lock in a lot of losses – something that would be disastrous for your goals.
What specific investments should you use? I have no specific recommendations, other than keeping your fees as low as possible. I have used Vanguard for many of my investments over the years and I invest in their index funds because they have low costs and usually just match the market, which is all I really want. My cash is mostly in ING Direct.
If you do one thing, do this – think about what your goals are, whether you have money to invest now or not. Knowing where you’re headed makes the journey infinitely easier.