The Dangers of Financial Paralysis – And How To Get Out Of The Rut

Scream!For several months last year, I was completely in financial lockdown mode. I had figured out that I needed to start saving money, and I also had figured out that I needed to get out of debt, but once I had all of my loans paid off (at least, all of my loans with an interest rate above 5%), I realized that now was indeed the time to invest because I could get a much better return on my money than simply paying off the loan.

So what did I do? Nothing. For several months.

I first reached a point where I was going to invest in July 2006. I had some money to begin investing, but instead of actually going through with it, I sat on my thumbs. I made double payments on my remaining loans and kept sweating about what to invest, how to invest, and so on, and basically just took potential gains and flushed them down the toilet while I sat there in what I call financial paralysis. Because of it, I missed out on a wonderful stock market run during the second half of 2006, where I could have made a 10% return on my investment in just a few months. Plus, the delay meant I spent several months with rather poor financial discipline because I wasn’t dedicating a portion of my income to investing.

This is apparently a fairly common condition, however, brought on by several factors: the huge array of investment options available, the sense of “missing out” if you choose something with lower gains, a fear of actually losing money, and also the overall change in perspective that comes from committing a regular amount of money to a true investment. It can also take a lot of forms, including spending hours doing research but never making any decision at all, or simply postponing doing any research or making any move at all.

If you’re ready to start investing, but don’t know where to start and feel paralyzed, here is a six step plan to break through the paralysis without losing too much.

1. Start putting the money away immediately. This is the most important thing. If you’re going with a regular investment plan (and you should be), start socking that money away immediately. If it’s tax-deferred, simply ask your investment advisor where a good default place to put the money is, as you can move from fund to fund within the account without penalty. If it’s not tax-deferred, open a high-interest savings account (like the offerings from ING Direct or HSBC Direct) and start putting your investment money in there until you’re ready to make a move. That way, you start working on the financial discipline aspect of it and also earn a decent percentage (4-5%) as you wait.

2. Get comfortable with the fundamentals. Read a good general investing book, like The Bogleheads’ Guide to Investing, and get up to speed on the fundamentals of investing. Have some idea of what you’re doing before tossing your money in.

3. Figure out your actual risk tolerance. There’s no tried and true formula for this, but spend some time thinking about it in general. How much of your investment would you feel okay with losing before deciding to bail out? For me, if an investment has a long term and healthy history, then I have a pretty big risk tolerance, meaning that I could invest in blue chips and ride their cycle without much worry. The important part here is to be honest.

4. Narrow down your investment possibilities. Are you going to invest in managed mutual funds? Index funds? Individual stocks? Bonds? After learning about investing fundamentals and understanding your risk, a general class of investments to start with should be clear. From there, keep narrowing it down. Look at the reputation of various investment houses. Look at Morningstar or the Money 70 for ideas. Don’t be afraid to eliminate huge numbers of investments – there are plenty more fish in the sea.

5. Pick a small group of possibilities and study them carefully. Before long, the group of possibilities should get nice and small. Track them for a while. Study them in detail. Whenever any one makes you feel uncomfortable at all, axe it and move on without hesitation. Eventually, the number will be so small that…

6. Take the leap. If you’ve found a single investment or a group of them that really match your risk and your investment philosophy, jump in. If you did step one, you should already have the starting capital to invest, so just go for it and enjoy the ride.

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