Many investors start off without having a strong foundation, and that often leads to disappointing results. To make sure that doesn't happen to you, follow these five steps.
1. Have a Plan
A solid financial plan tells you what you need to achieve financially to achieve your life goals. Once you know how much money you'll need and when you'll need it, you'll find it easier to decide how to invest. Without creating a financial plan, it will be difficult to keep your investing habits in perspective and stick to your investment strategy. That's the next step.
2. Have a Strategy
Your investment strategy tells you what to buy, when to buy and when to sell. You determine your strategy by balancing what you need to achieve financially with your desire to minimize risk. Let's say you decide that you want to retire in 15 years. After running your plan, you determine that you need to take your existing savings, add $30,000 a year and grow all that money to achieve your goal. If you can achieve your goal without taking much risk, your investment strategy might be very conservative and give heavier weight towards fixed income. If you need to be more aggressive to end up where you want to be, you might need to tilt more toward equity growth. As you can see, your financial plan should drive the "what should I invest in" decision.
To determine when to buy and when to sell, you have to decide if you are a buy-and-hold or tactical investor. All approaches to buying and selling stocks and funds have pros and cons. Depending on how you invest, if you are a buy-and-hold investor, your returns will likely mimic those of broad indexes.
That's great when the market is good -- but it can be heart-wrenching when things go haywire. If you decide to try a more hands-on approach, make sure your investment strategy is rules-based rather than emotion-based. The last thing you want is to make buy/sell decisions based on how chipper you feel on any particular day. That's a sure recipe for disaster.
3. Learn the Basics
You'll be richly rewarded if you understand how stocks and bonds work before you start investing. Each alternative has a unique risk profile. When you buy bonds, you are basically loaning someone your money. They pay you interest during the period of the loan and at the end of the period they repay the money they borrowed (if they are still in business).
If you buy very solid bonds, you can minimize the risk of losing your capital, which is great. But the safer the bonds are, the lower the interest you receive. It's a tradeoff. Many investors prefer to buy stocks and stock funds or exchange-traded funds if they are planning on investing for a long period. That's because they feel they can do far better with stocks than with bonds. Of course, if they put more money in stocks, they are subject to much more risk -- especially over the short term. This issue of risk and volatility is crucial to understand.
You need to invest with your eyes wide open and expect the bad along with the good. If you ignore your risk, you might be shaken out of your investment strategy at the worst possible time. But if you take a little time to learn how these investments work, the odds of that happening are lower.
4. Set Up Your Platform
If you are going to do your own buying and selling, there is no reason to pay high commissions or fees. Dozens of online brokerage firms are eager to open an account for you. It's very easy and quick. Just make sure you do business with a reputable company with low fees and high-end research capabilities.
5. Pull the Trigger
Start slowly. Don't let your emotions cloud your judgment. You might find it useful to print out a list of your investment rules and use it as a checklist to make sure you've covered all your bases.
Are there other concerns? What other areas do you think a DIY investor needs support in? Share your comments below.