How to Choose an Investment: 7 Questions to Ask

Investing is a powerful tool for building wealth and achieving your financial goals. But it’s not something you should just jump into. Successful investing requires careful planning, research, and an understanding of the different factors that can impact your investment outcomes.

Today, I’m going to give you 7 questions to assess potential investments and figure out if an investment is a good choice for you.

1) Does this align with my goals?

Before you start investing, it is crucial to define your goals. Why are you investing? To build wealth and be able to retire? To grow your savings until your kid goes to college? To take advantage of a booming real estate market?

Understanding your objectives will help you determine the appropriate investment strategy, time horizon, and risk tolerance (and if you don’t know what those words mean, don’t worry; I’ll explain in a minute).

Clear goals will provide a roadmap for your investment decisions and keep you focused on the long-term, so before you do anything, write down your goals for investing.

2) Does this fit my risk tolerance?

Every investment involves some level of risk, but some investments – like stocks – tend to have a higher risk than other investments – like bonds.

Risk and returns go hand in hand (i.e., the higher the risk, the higher the reward) so finding the right balance between risk and reward is crucial.

Riskier assets tend to have more ups and downs (or volatility) while less risky assets are more stable (less volatile).  

Decide how much volatility you are comfortable with and consider factors such as your age, financial obligations, and personal circumstances to make this decision.

For example, if you have a stable income, minimal debt, and a robust emergency fund, you may be more willing to tolerate higher investment risks. On the other hand, if you have significant financial responsibilities or a more uncertain income stream, you may opt for a more conservative approach.

Generally speaking, the longer your time horizon, the more risk you are probably willing to take on because you have more time to let the market go up and down before you need to take the money out, so you might be up for more risk in exchange for a higher reward.

If you’re closer to retirement or needing to use the money in the next 10 years, you’ll likely want to build an investment portfolio that’s slightly more conservative so it doesn’t have as many ups and downs.

Adding a variety of different investments into your portfolio can also help lower your risk, but I’ll get to that in a minute.

3) Does this match my diversification strategy?

"Don't put all your eggs in one basket" is a common investment adage for good reason.

Diversification is a fundamental principle of investment risk management. By spreading your investments across different asset classes, industries, and geographical regions, you reduce the risk of loss from any one type of investment. Diversification provides a cushion against market volatility and helps balance the overall portfolio performance.

Think about how the investment fits within your overall portfolio and its potential contribution to diversification.

For example, if you were only invested in real estate and you were considering adding another property to your portfolio, this wouldn’t necessarily be adding much in terms of diversification. Instead, you might want to add some stocks.

As you’re considering a new investment, evaluate how it aligns with both your risk tolerance and diversification goals.

4) Does this align with my time horizon?

Your time horizon is the length of time you are willing to leave your money invested before taking it out.

Short-term goals, such as buying a car in a year, may require low-risk investments, like a one-year Treasury bond. Long-term goals, like retirement planning, can allow for higher-risk investments with the potential for greater returns, like stocks.

Align your investment strategy with your time horizon to maximize the growth potential of your funds.

5) How much does it cost and what are the fees?

Investment costs and fees can significantly impact your overall returns.

Beyond the upfront cost of making an investment, there are likely other expenses. Before making an investment, understand the expenses associated with it, including management fees, transaction costs, and taxes.

Look for low-cost investment options such as index funds or exchange-traded funds (ETFs) that provide broad market exposure at a lower expense ratio.

Unless you’re building a values-aligned portfolio and have specific desires to pay higher fees, you can generally look to avoid paying any fees above .3% when you’re investing in the public markets.

For example, Fidelity’s 500 index fund has a 0.02% expense ratio. Vanguard’s total stock market index fund is 0.04%, and Vanguard’s target date funds have an expense ratio of .15%.

Generally the difference between .15% and .45% isn’t going to make a huge difference, but when you pay a financial advisor 1% management fee on all your assets in ADDITION to the expense ratios involved in the individual funds, it can add up.

If anyone is trying to charge you 1% or more to manage your money, the general rule is to RUN in the opposite direction! Unless you have reason to believe you’ll get exceptional returns, or strong values-alignment. But more on that in another video ;)

6) What’s its liquidity?

Evaluate the investment's liquidity, which refers to how easily it can be bought or sold without significantly impacting its market price. Consider your ability to exit the investment when desired and the ease of converting it into cash.

For example, if you invest in an I bond, then you can’t cash out for at least a year and there is a penalty for cashing out in under 5 years.

But just because you can technically liquidate an investment easily doesn’t mean you should.

For instance, if you invest in the S&P 500, you can technically cash out at any time, but if you don’t give your investment time to grow, you’ll likely be losing money. As a general rule, when you’re investing in stocks, you should plan to invest your money for at least five years.

Investments with low liquidity may be suitable for long-term commitments but can pose challenges if you need quick access to your funds.

This is one reason it’s important to build an emergency fund BEFORE you invest. That way, if your roof starts leaking or your car won’t start, you aren’t forced to liquidate your investments to handle that problem. (And we recently published a video on how to build an emergency fund, which I’ll link in the description if you want to check that out!)

If you want to invest but you’re also not ready to commit your money for a long period of time, I suggest looking into Treasury bills (also called “T bills”) or certificates of deposits (CDs). These are easy ways to grow your money but you can also easily liquidate them without huge penalties.

7) What is the market doing?

I don’t recommend trying to time the stock market. If you want to know why, I explain it in our investing mistakes video, which I’ll link in the description, but suffice to say, it’s a stressful and ineffective way to invest.

But that’s not to say you shouldn’t pay attention to what’s happening in the market. For example, in early 2022, the US was in the middle of record-breakingly high inflation. Because of that, stocks were down, but more importantly other investments were up – I bonds offered an almost 10% return and the interest rates on high yield savings accounts were rising.

When the stock market is down, don’t panic…it’s actually a great time to invest at a lower price. But stay aware of other lucrative investing opportunities as well.

Remember…

Investing can be hugely rewarding, but it requires thoughtful consideration and informed decision-making. By following these tips, you can increase the likelihood of achieving long-term financial success. Remember, patience and discipline are key when it comes to investing, and seeking advice when needed can provide valuable guidance along the way.

‍