Investing is an important tool for building wealth and helps your money grow faster than just saving. By investing, you can make your money grow through compound interest. As a financial planner, I speak with countless people who are new to investing. Today we have access to
on our cell phones, and the process is so simple it feels like a game. Between social media, online forums and search engines, we have an endless amount of information (and influence) at our fingertips. hand. Cocktails and discussions around the water cooler are a thing of the past.
With increased access, it’s hard to decipher useful and valuable investment information from nonsense. Even when you find the right information, it can be difficult to understand which investment measures are right for you; this is where mistakes – and sometimes regrets – come in. Whether you are just starting out or have been investing for a while, watch out for these common investing mistakes.
1. Don’t cover the basics first
Before you dive into the world of investing, take a look at your current financial situation and make sure you cover the basics. Are you contributing to your 401 (k) at least up to your employer? People often skip this step, but it’s the easiest way to start investing. When your employer matches your contributions, it’s free money and a guaranteed return on your investment.
Do you have money set aside for a rainy day? Building an emergency fund should be a top priority. Your emergency fund is there to cover unforeseen expenses or job loss. Having this fund can help avoid unnecessary debt and additional stress. When it’s time to dip into your emergency fund, you’ll appreciate having easy access to cash and not having to sell your investments, especially if your investments have lost money.
Do you have high interest debt such as credit cards or personal loans? Debt can take a toll on your budget. If you don’t aggressively pay off a high interest rate debt, the interest really adds up and the balance can become difficult to pay off.
When deciding to pay off debt or invest, follow a general rule of thumb: if you can earn more interest by investing than you pay on your debt, it makes sense to invest. The average credit card interest rate is around 16%, and rates can go up to 30%. While some investments have the potential to earn so much, you should consider that these types of investments can be very volatile. Plus, paying off debt improves your credit score, which can affect many aspects of your finances.
2. Not having a plan
Knowing why you want to invest and what the money is for are two critical considerations. Will you need this money in the next few years, perhaps to buy a house? Like an emergency fund, avoid investing cash that you will need to access in the next two to three years. You wouldn’t want to be in a situation where you need cash and have to sell your investments at a loss. If you’re saving for retirement and you’ve covered the basics, you have time to take on more risk with your investments.
In addition to the time horizon, consider the type of investment account. I always encourage clients to build investment assets into three categories, taxable, tax-deferred, and non-taxable. Taxable accounts, such as brokerage accounts, are funded with after-tax dollars. You pay dividend and interest taxes each year and capital gains taxes on any capital appreciation when you sell the assets. Tax-deferred investments include a traditional 401 (k) and traditional IRA, while non-taxable assets include Roth 401 (k), Roth IRAs, and health savings accounts (HSAs).
Finally, what are your long-term goals and how will investing help you achieve them? How much should you invest over time? The category (or combination) of investment accounts to use and the types of investments will vary depending on your situation. Answering these questions before investing and having a thoughtful plan will help you stay the course.
3. Not understanding the risk
You may be drawn to specific types of investments, like individual stocks, cryptocurrencies, or rental real estate. When you haven’t covered the basics and don’t have a long-term investment strategy, it’s easy to be drawn to what seem like quick and easy returns. But all investments carry some level of risk, even the most “boring” ones.
To understand the potential risk associated with an investment, assess how much you can expect to lose, the opportunity to gain, and how easily you can withdraw your money from an investment. Don’t trust the stories and advice of friends, colleagues or social media influencers. Most importantly, if someone promises or guarantees returns on their investment, run fast in the opposite direction! Do your own research and determine if a particular investment strategy is right for you.
It would also be best to understand the level of risk you can personally manage and the level of risk needed to achieve your goals. Everyone’s ability to take risks is different, and there is no right or wrong answer as to how much risk you should take. If a particular investment strategy causes anxiety or keeps you awake at night, it may not be for you. You could have a high savings rate or a large amount of assets. In this case, you may not need to take a lot of risks to achieve your long-term goals. Just because you can earn more on your investments doesn’t mean you should. Protecting your savings is just as (if not more) important than growing them.
Investing is a great way to accelerate progress towards your long-term goals. Investing on the spur of the moment can turn into a gamble, and you have the potential to put your savings at risk. Although investment mistakes are common, they can be easily avoided. Before you dive in, make sure you cover the basics, understand the risk, and most importantly, have a plan.