Investing: Questions you need to ask BEFORE investing
Here are 4
Important Questions to ask before putting your money to work
- Why am I saving this money?
- What am I going to use it for?
- When do I need the money?
- What level of risk am I comfortable with?
For example, Lets say you want to accumulate money for a down payment on a
home that you'd like to buy in a few years. You can't afford much
investment risk with that money. You're going to need that money sooner
rather than later. Putting that money in the stock market is not a wise
move because the stock market can drop quite a bit in a year or over several
consecutive years. So, stocks are probably too risky a place to invest for
a down payment money you plan on using later. In another case, if your were to
save for retirement, that is 20 to 40 years away. You should consider investing
in growth investments like stocks. Since you have time on your side, you
can tolerate year-to-year volatility in the market and your holdings will have
more time to bounce back from temporary losses or setbacks.
How to make your money work hard as you
do:
If you don't spend less than you earn, you'll never be rich. In fact, it will
be difficult ever to achieve any financial stability whatsoever. But to really
start accumulating wealth, you need to make your money work as hard as it can
for you. And that means putting it in places where it will earn the best
return. For example, most checking accounts don't pay interest. So the money
you leave there to pay bills isn't earning anything. But almost all banks
offer a money-market type of account that does earn interest. Keep most of
your available cash in a money-market account at your bank, and when you're
ready to pay your bills, transfer the money from the money-market account into
your checking account.
Where should you keep your emergency reserve
funds or additional cash you're saving? Put it in the account that pays the
most interest. For example, let's say your bank offers passbook savings
account that pays 2 percent on funds. Two percent is better than stuffing your
cash underneath your mattress. However, the average annual rate of inflation
over the past century has been around three percent. Basically, that means
everything you buy will cost you 3 percent more next year than it does this
year. So if your cash is earning 2 percent and inflation is 3 percent, you're
actually losing 1 percent of your money's buying power every year. You're
losing money!
There are two main ways your money can grow,
either by being a lender or an owner:
Be a Lender - When you invest your money in a bank certificate of deposit, a Treasury bill,
or a bond issued by a government or a company like McDonald, you are in effect
lending money to - a bank, government or Corporation like McDonald. You
are paid an agreed-upon rate of interest for your money. You are also
promised to have your original investment which is also called the principal
returned to you on a specific date.
Advantages of being a lender: You are paid all of the interest in
addition to your original investment (principal) as promised.
Disadvantages of being a lender: You don't get everything you were
promised. When a company goes bankrupt, for example, you can lose all or
part of your original investment. Also as a lender, you do not share in the
success of the organization to which you lend your money. If the company grows
in size with lots of profits, neither your principal nor your interest will
grow; they will stay stay the same. Of course, when the company is successful,
it ensure that you will get your promised interest and principal back.
Be an Owner - You become an owner when you put your money in an asset, such as company's
stock or real estate. They both have the capacity to generate income, earnings
or profits. Suppose you buy 100 shares of McDonalds stock. Your 100 shares
represent a very small piece of ownership in McDonalds.
Advantages of being a owner: As an owner or a stockholder, you
share in the profits of a company in the form of annual dividends as well as an
increase in the stock price if the company grows and becomes more profitable.
Real estate can produce profits by being rented out for more income than
expenses or selling at a
higher price than what you paid to buy it.
Disadvantages of being an owner: The downside of being an owner
is that if McDonalds stop growing or people stop eating at McDonalds, your stock
can fall or even become worthless when the company goes bankrupt. With real
estate, it takes a lot of work and time. You may also have to deal with problem
tenants and fixing up the property.
The stock market has returned, on average, a bit
better than 11 percent per year for the past decades. That's why so many
financial experts recommend putting your money into the stock market. But the
stock market is a long-term investments. You only want to invest money that you
won't need for the next five to ten years. It isn't the place to put funds
you'll need in the next two years, because stocks rise and fall (that's called
volatility), and no one knows when that's going to happen.
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