3 simple questions you need to ask yourself before you invest a penny.
Investing for the first time can be daunting. There is a huge amount of information available online to educate yourself on finances and investments, but finding the stuff that applies to you can be a real needle in the haystack situation.
Before you even get to this point, you need to understand whether investing is right for you, and whether you are ready for it. You need to have an investment ready mindset.
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This is really important, because investing can be a real rollercoaster ride. We live in a time where crazy, unexpected events seem to be around every corner, and investments markets feel all these lumps and bumps we see in our daily lives.
When I sit down with my clients, there are 3 questions I always ask first before we even begin to talk about different ways to invest their money. Asking yourself these 3 questions can be a great first step on your own investment journey. It can help you make sure you are mentally prepared for what investing involves.
How long until I need this money?
The length of time you are prepared to invest for is the most important thing you first need to establish. Investing in growth assets like shares means that at some point, your money will go down in value. The problem is that no one knows for certain when this will happen. It could be after you’ve been investing for 3 years, or it could be the day after you transfer your cash in.
If your expecting to need to get hold of your money in less than 3 years, you shouldn’t be considering investing. Say you are saving for a house deposit. You want to buy somewhere in 1 to 2 years time. Investing in the stock market means that there is every chance your account will actually be worse less than when you first started.
With short timeframes, this just isn’t a risk you should be prepared to take. Even the most iron clad money mindset is going to take a battering if the portfolio is down 15% and you need the money in 3 months time.
On the other hand, if you don’t plan to need the money for 3 (or ideally 5) years, then investments might actually be right for you. The important thing to remember is that for most investments, this isn’t a lock in period or an exit fee that stops after 3–5 years. It’s purely the fact that your investments could be down over that period of time.
The other reason why this is really important is because you can start to think about how risky you can be with the money. Investing with a 3 year timeframe in mind means you are still probably going to need to be pretty conservative with your portfolio. You can still invest in the stock market, but not with a high percentage of your money.
If however, you aren’t planning on needing any of your money for 10 or 15 years, you can afford to take a lot more risk. Even if your investments move up and down a lot, it’s likely that in 15 years’ time all these large swings will look like a blip on the graph.
This first step ensures that the investments you go ahead with are fit for purpose. It gives you a clear timeline on how long you are committed for, and this can help immensely when times get tough. If you’ve invested with a timeframe of 10 years and markets get volatile after 2, your mindset will be right because you’ll know your still very early in your investment ‘race’.
What return do I need?
Now that you know how long you are prepared to invest for, the second question you should be asking yourself is what return you need. In order to know this, you need to understand what you are investing for and what you are trying to achieve with your money.
This could be a lump sum you are saving for like a house deposit, or it could be funds to provide you with an income like in your retirement.
Once you know what amount of money you are trying to grow your funds to, you can then work out what level of return you need in order to achieve your goals.
The reason why this is important is because it plays a big part in choosing how much risk you need to take with your portfolio. For example, if you have an objective that is going to be really easy to achieve, you might only need a 1% return from your investments in order to reach the goal. In this case, taking a high level of risk in order to get a 7% return is not necessary, and means you’re taking more risk than you need.
It’s like having an hour to drive 2 miles down the road. You could drive below the speed limit and get there in plenty of time with no stress and no worries. Or you could drive at 30mph over the speed limit. You might get there a few seconds earlier, but you could also crash along the way or end up with a whopping speeding fine.
Taking risk you don’t need to take should be avoided. Knowing the risk you need to take, means you can avoid it where possible. Exposing yourself to unnecessary risk is a sure fire way to fry your investment mindset.
How will I feel if the value goes down?
No, I mean how would really feel if you were sitting at home in your pyjamas, staring at an online account that showed your investments down £10,000.
It’s really easy for us to brush off the idea of stock markets moving up and down when we talk about it in a general way. We can look at graphs that bump up and down all over the place and think, “Yep, that’s fine with me”. It is a very different feeling when it is your own money dropping in value.
The reason for this is because there is no emotion involved in looking at a chart showing what’s happened to someone else’s money. At that point it’s a purely logical exercise. Unfortunately when it comes to investing we are not robots, and we have emotions. It’s these emotions that can get us into serious trouble.
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When we see stock markets plunging, we can become very scared about what this might mean. How far will it go? Will I lose everything? Will that mean I’ll never retire? Fear is one of the strongest emotions we can feel, and it triggers the fight or flight response in us. This creates a situation where we have an overwhelming desire to act, to do something, to fix it, to remove ourselves from the situation.
In most circumstances, the best thing you can actually do is absolutely nothing. We have seen so many market crashes in the last 120 years, and every single time the markets have recovered to beat their previous high. It sometimes takes a good few years, but it always happens. Your ability to ride out this storm is vital to the success of your investment portfolio.
This isn’t about scaring you into not investing. Thinking about these questions early just means that you can deal with them upfront. You can set yourself up for success by planning for the worst at the outset. That way, when the worst does happen, you don’t need to be concerned.
You can calm that fear monster that tries to take over, knowing that you’ve already acted, you’ve already done something, and that you are going to stick to the plan.
Answering these 3 questions will ensure that your investment mindset is solid, and you can survive through anything that markets throw at you.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.