One of the most common questions I am asked about personal finance and investing is where to start. There are so many options to invest today, it’s overwhelming. Types of investments include individual stocks and bonds, mutual funds, ETFs, interest bearing bank accounts, CDs, options, annuities, real estate, and cryptocurrencies, to name a few.
Before diving into any one particular type of investment, it’s important to first understand your goals and time horizon. When you think about your goals, consider how important they are to you and your family. Asking what’s at stake if you don’t achieve this particular goal can be a useful way to then understand how important the likelihood of success of achieving your goal is to you.
What’s most important to you?
Have your priorities clearly defined. Once you have identified your goals, if you have more than one, try to rank them in order of importance. This will help you prioritise where to focus your efforts. Be mindful that your goals may change over time, which is fine. Do this before considering investments. It can be very easy to get swept up in the excitement of a particular opportunity or to feel like you are missing out on something. It’s important to have your own game plan and also to write it down. Goals may be the purchase of a car, home or vacation, or to graduate school, take a sabbatical or have a child. They are personal and for you to determine for yourself.
When do you need to make something happen?
The next thing to do is specify a timeframe of when you would want to achieve each goal. Taking into consideration when you will need to have achieved your goal is a critical factor that will help you figure out the most appropriate investments and approach to take. Try to make it easy, and consider a short-, medium-, and long-term time frame. Generally, short-term covers less than three years, medium-term would be three to ten years, and long-term lasts longer than ten years.
Your age or the type of lifestyle you’re looking to build for yourself will influence which goal goes with which time frame. Gone are the days where ‘retirement’ is a long-term goal. Thanks to the myriad ways we can earn a living, people have become much more creative in how they spend their time. A sabbatical, semi-retirement, or early retirement may be what is most appropriate for you. It’s important to note that some people never fully retire. Think of a consultant, university professor or artist. You may choose to work as long as you wish, however, the way you work may look very different later in life than early and mid-career. The bottom line is that retirement is not necessarily something you plan for once you reach 65 or 70 years of age; take into account whether this is a temporary or complete exit from the workforce. Then structure your investment goals based on your needs.
Risk versus volatility – know the difference
Once you have determined your goals in order of importance and timing, next consider risk. Risk is any uncertainty that may result in a decline or loss in value of your investments. The more important a goal is to you, or the shorter the time horizon for when you want to reach that goal, then the more you want to reduce the risk or probability of loss of that investment. How do you assess the riskiness of an investment? In the case of a stock investment, consider the cash flows generated by a particular company and determine how robust and durable they are and if they will continue into the foreseeable future. Think about that company’s competitors, how innovative the company is and whether the business has been able to build a moat around its products and services such that it would be difficult for another player to take market share away. This will give you an idea of how resilient the business is and whether you can count on that company’s cash flows to sustain a healthy economic return in service to your goal.
Now that we’ve covered risk, let’s talk about volatility ‒ it’s important to understand the difference between the two. Volatility is how quickly the price of an investment moves up or down within a certain time frame. This may have less to do with the “risk” of an investment than you think; they are not necessarily correlated. In addition, some volatility can actually be good and can work to your advantage. For instance, when the stock market crashed toward the end of February 2020 because of instability triggered by COVID-19, this was a good time to buy stocks in high-quality companies whose prices were much lower than they would be under normal circumstances. Many of these companies quickly rebounded because they were sound companies with healthy businesses producing quality cash flows.
Investing doesn’t have to be difficult or complicated. Everyone can and should use investing to achieve their goals. In order to be successful, have a gameplan with your prioritised goals and time horizon clearly laid out, and use this as a framework with which to assess different types of investment opportunities. As you evaluate different investments, be sure to consider risk or the permanent loss of capital and don’t be afraid of a little volatility. Buying low and selling high (or higher than what you bought at) is always a good strategy.
Cory McCruden is an online columnist, motivational speaker, entrepreneurship and expert on financial wellness and the future of personal finance. Cory is the Founder of Norstar Insights and an Entrepreneur In Residence at Yale University.