More details are available in this article regarding the six questions that successful investors should ask themselves while building a portfolio of stocks and other investments.
1. What does my personal financial situation look like?
Personal finances and investing are intertwined, but it’s best to consider them as distinct factors. You should look at your overall personal financial situation when deciding when and how to enter the stock market. Before investing your money, make sure you are coming from a strong financial position. This means having a sense of financial security.
To start, build an emergency fund that equals three to twelve months of expenses. Ensure that you can survive if you lose your job or find yourself in a situation with a lower income. Next, work on eliminating high-interest debt such as credit cards and personal loans. Make sure you are not paying more interest than you are earning from the investments you currently have or are considering acquiring in the future.
It is important to assess debt and liquidity beforehand. The last thing you want is to need to liquidate your investments to solve a financial problem. This would disrupt the process of building your wealth. Time is the factor that supports the growth of your capital more than any other.
Once your finances are under control, it is time to focus on an investment strategy that aligns well with your income, routine cash flow, and short- and long-term goals and dreams.
2. When will I need this money?
Your financial goals may help you make investment decisions. There are various investment strategies to explore, depending on whether you are investing for the short term or long term.
Suppose you are in your thirties and looking to build a retirement fund. This means you are likely looking at a 30-year investment timeline. If that’s the case, you might be better off using a buy-and-hold policy for your equity investments.
For example, by August 2021, the ten-year average return on the S&P 500 index was 13.97%. Assuming the same average return for the next 30 years, a one-time investment of $1,000 in the S&P 500 would grow to $50,549.45 by the end of that period.
The conventional investment guideline states that if you are young and have a long time before retirement, you should be bolder in your investment choices. While this is not bad advice, there is no one-size-fits-all option. Some investors focus on yield, which is the amount your investments generate for you in income. This approach can work with stocks, mutual funds, and bonds. It is better if you own a basket of high-quality stocks that pay good and increasing dividends.
If you wish to use the yield from investments to buy a car in five years, for example, you might want to take less risk and consider saving products like short-term certificates of deposit or money market funds.
3. How much risk can you tolerate?
This is one of the most important questions you should ask yourself before investing. It can be answered simply by considering how much money you can afford to lose if your investment moves backward or fails.
The allure of high returns in stocks or other assets like cryptocurrencies can be strong, but their significant price volatility can unsettle even the most dedicated investors. Since 2020, we have seen a surge of individual investors into the stock markets, especially with trading apps that make buying and selling extremely easy.
Many
Investors are attracted to “meme stocks,” which see an increase in volume not due to the company’s performance but because of promotion on social media and online forums like Reddit. These stocks often become overvalued and experience significant price spikes in a short time, but they can lose value just as quickly. Avoiding them or trying your hand at investing in them cautiously can indicate your risk tolerance.
4. Does this investment help hedge other investments?
Stocks are considered to carry the most risk and offer the greatest potential for high returns. On the other hand, bonds typically earn lower returns on average but come with less risk.
How to fill your portfolio with stocks, bonds, cash, and other investments depends on your needs, such as having quick cash liquidity, time frame, your risk tolerance, and other unique circumstances. Assess how you will diversify your investments using asset classes.
If you are buying stocks, will you put all your money into high-flying tech stocks, or will you spread your investments by buying and holding defensive stocks from companies with a long history of paying dividends?
Determining these factors will help you define the approach you want to take when investing. There is no specific category you will fit into. It’s about finding your comfort level across and within assets.
5. What are the costs associated with this investment?
If you are purchasing an investment product like a stock or even a mutual fund, you are paying a certain price for that, but there are other costs you should also look at. Before choosing how to invest your money, consider the following.
Am I paying too much for this investment?
Valuations, especially for stocks, can be tricky. How can you tell if you are paying too much for a stock or getting it at a discount? If the stock is already valued at too high a price, it may not yield significant returns. It might be subject to a price correction that can diminish your investment value. Do the necessary research on the company’s financial situation, sector outlook, and how other stocks in the sector are valued to decide whether the stocks are overpriced.
If you know you want to invest in a specific stock but are unsure about the price, you might want to consider dollar-cost averaging by investing smaller amounts regularly instead of making one large payment.
Fees and expenses
Be aware of the costs associated with trading stocks. Often, a fee is charged for each transaction. If you trade frequently, these costs can add up. Some discount brokers have eliminated transaction fees, but beware of other hidden fees.
Mutual funds also impose various fees and expenses, some of which are clear and others that are not. For example, if you put $100 into a mutual fund with a front-end sales charge of 4%, then only $96 of your money will actually be invested.
If you are working with an investment advisor, also consider the fees or commissions they charge you for helping you invest your money.
6. How much tax will I have to pay?
A good investment isn’t just about putting money into a product and watching it grow. It also involves pulling money out and using it. However, capital gains taxes can affect the value of your growing investment.
When considering selling your investments, remember that profits from assets held for less than a year are taxed as ordinary income. Gains realized after a year or more are taxed as long-term capital gains at a much lower rate.
Strategy
Another tax you should be aware of when investing is “tax loss harvesting.” Often, capital gains can be offset by capital losses you incur during the same tax year or that have been carried over from a previous tax year. This method can reduce capital gains taxes and may lower your tax bill.
Conclusion
Given the significant increase in interest in the stock market – driven by the pandemic – there has never been more investment advice available online. While this can be helpful, some of it takes a one-size-fits-all approach.
To build an ideal portfolio for you, create a plan that fits your unique financial situation. From there, adjust the plan to match your goals and the investment style you feel comfortable with. If buying stocks or any other asset causes concern or anxiety, you should take the time to think about what you’re doing and where your money is going.
With the additional interest we are paying to investing these days, there have never been more options for the individual investor. Fintech platforms and online research provide you with the resources you need to make your investment decisions. It’s also helpful to have access to a financial advisor you trust, who can assess your overall financial picture and help you create a comprehensive investment plan that aligns with your life and goals.
Source: https://www.thebalancemoney.com/6-questions-successful-investors-ask-4091361
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