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Financial Sanity 101: 6 Steps To Understanding Investing

Financial Sanity 101: 6 Steps To Understanding Investing

  1. Investing is distinguished from savings by the introduction of risk. As I discussed in my post about savings, a good savings plan is not exciting because it does not involve risk. A savings account involves a stable interest rate, with low returns and little expectation of gain. You just want to keep your savings somewhere safe while you are waiting around to use it. Investing is different because it concerns money that you want to grow, and that you are willing to risk in order to grow. Investing is done with money that you do not need today, and that you do not anticipate needing for at least the next five years.

  2. The level of risk involved in investing varies greatly according to types of investment, and can be adjusted to your comfort level. Lately, just putting your money in the bank seems a little risky. This is not ordinarily the case, but investing your money always involves an element of risk in exchange for a chance at a higher reward. How much you are willing to risk your money depends upon a variety of factors, including the amount of money you have to invest, how much time you have before you may need to use your money, current economic climate, et cetera. Assessing risk is the skill you need to acquire if you want to be a successful investor.

  3. Investments are used for funds such as retirement, college savings, and general wealth-building. You do not put your emergency fund in an investment fund. Similarly, you do not use your short-term savings funds (such as new car funds, christmas funds, or house downpayment funds) for investments. You cannot afford to expose these monies to any kind of risk, and besides, you will need to use the principal from these funds long before you can hope for a significant return.

  4. Sane, smart investing requires patience and persistence. This is particularly true in the current market. You cannot put your money in the market today and expect a return any time soon. Yes, I know there are day traders and hedge fund managers out there who will tell you different. If you have a ton of money to dick around with, then I invite you to try these tactics. Try to steer clear of ponzi schemes, at the very least. However, if you are like me, and just looking to retire without having to eat dog food, then I beg of you to approach the market in a smart way. Losses are not losses until you sell (or, in the case of people who owned Lehman Brothers stock, until your company goes out of business). So, if you see your 401K going down a lot lately, remember that this money is meant to be in there a long time. If you sell now, you are guaranteeing a loss. If you hang in there (with a well-managed portfolio), you can hope to do better in the future.

  5. You should never, ever buy a product you don’t understand. Investing is a complex topic, and you won’t understand everything about it today. That said, there is no hurry. Do not go out and buy mutual funds without understanding what they are. Similarly, if you choose to buy single stocks, do not do so without understanding the company and why it is a good investment. I don’t care who your sister-in-law works for, or what your golf buddy told you. You will not feel safe and confident about your money until you understand where it is invested yourself. A good resource for researching investment products online is Morningstar, or if you go to a brick-and-mortar investment company, you need to find a broker with the ability to teach you about all of the products he or she is endorsing.

  6. Learning about investing is a lifelong process. You will make mistakes when you invest, no matter how well-prepared you are. The market is unpredictable and surly, even for seasoned investment professionals. Your best bet is to keep learning and keep assessing your risk and your risk-tolerance as you go along. The rest will come with time and patience.

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