So you’re ready to buy your first investment. Here’s your eight-step checklist.
As a beginning investor, you’ve done some research — maybe even bought a book or two, to educate yourself on what you’re doing. If you’re lucky, your employer or community group sponsored a webinar to get you started with investing. You might also have asked people you know are knowledgeable on the topic for their opinions. Being successful in personal finance means taking control of your behavior more than anything else. So are you ready? Here’s a checklist for what to think about when you’re ready to buy that security.
1.Do you understand, at least generally, how this investment works? You don’t need to be an expert in what you’re buying, but you should have at least a rough idea of how it works. Do you know in general what happens to your investment when the market goes up and when the market goes down? If it’s an annuity, do you understand how its guarantees (if any) work?
Example: you’re purchasing a large-cap index fund. The fund is expected to grow when the stock market is rising, and will lose value when the market falls.
2. If someone is recommending this to me, are they objective? If you don’t think the recommendation is objective, you should reconsider buying. If the salesperson has an incentive to sell you one product rather than another, that’s something you should think about. If you find out about the investment from an obscure website (not a well-known money manager or financial publisher) or from someone on TV whom you don’t know and who doesn’t know you, you should not buy — the people behind the website or the TV show are probably being paid to endorse it. You may hear about the investment from someone you work with, or someone in your family; unless they are professional money managers, you might not want to make the purchase (or at least not with money you can’t afford to lose.) A financial advisor who works with an open-platform company generally will not have an incentive to steer you to one investment over another. Advisors who work with insurance companies usually prefer to sell annuities and insurance, which may work for you if you need one of those products.
Example: you’re watching a financial news show and one of the pundits recommends a stock. It turns out that they are a paid spokesperson for the company. You decide not to buy it.
3. Does its risk/return match the time horizon I have planned for this money? If the investment doesn’t work with your time horizon, do not buy it, or at least not with money earmarked for that length of time. For example, you might find a great investment that requires you to lock up the money for ten years, but you’re investing to buy a house in five years. Don’t use the house money to buy it. You could look to see if the investment is available in your retirement account for your long-term plans.
Example: you’re buying a stock mutual fund, which is expected to perform over a longer period of time. This investment would be good for a retirement account, but not for the savings toward buying a home, which you expect to do in the next couple of years.
Similarly, cash does badly over a long time frame because it does not keep up with inflation, so it’s appropriate for an expense you have coming up in less than a year.
4. Is this choice consistent with my risk tolerance? If the investment doesn’t match, do not buy it with the funds you’ve set aside for that risk tolerance bucket. If it does work for a different risk bucket, you might consider purchasing it with that money.
Example: you’re putting retirement money in cash. If you have decades to go until retirement, cash does not match the high risk tolerance for that account. You’re better off investing the cash inside the retirement account.
5. Do I understand how this fits in with my overall asset allocation? If you don’t, you should reconsider the purchase. Will it cause your portfolio to be more aggressive/riskier, and if so, is that an effect you want? Or will it cushion you on the downside? Which, if you’re 20 years or more away from needing the money, you probably don’t want.
Example: you’re looking at an annuity that provides lifetime income, when you’re in your mid-forties. The annuity protects your portfolio on the downside, but you have a couple of decades to go before you need the protection. You might reconsider buying the annuity after you have retired and need more protection against stock market ups and downs.
Right now time is your cushion.
6. What are the costs/fees of this investment? There aren’t any hard and fast rules about costs, but you should understand them. Will you pay a commission to purchase the investment, or to sell it? Are there ongoing management expenses for the investment as there usually are for mutual funds? If it’s an annuity, are there M&E (mortality and expense) fees associated with it? If you purchase additional coverage or riders, what are the fees for those?
Example: you decide to have a financial advisor manage your money. They put your accounts on a 3rd party platform that charges 25 basis points (bps), or 0.25%, annually to hold your assets. Your advisor charges 75 bps annually to give you investment advice, so your total cost is 1% of your assets annually.
7. How do I sell it if I need to? Is there a period where my money’s locked up? Will I pay fees/penalties to get out of it? You need to know how you can get your hands on this money if it’s necessary, even when you’re not planning on touching the money for a long time. Stocks that trade on a public exchange, mutual funds, ETFs that cover large swaths of the market or well-known indices can generally be sold quickly and the proceeds sent to you within a matter of days. Individual bonds and sector or leveraged ETFs may be more difficult to liquidate. Insurance products generally have a surrender period during which you will pay a fee if you take money from the investment, and, if you’re under age 59 ½, retirement accounts will also require a penalty.
Example: you buy an 18-month Certificate of Deposit (CD). The interest rate they pay you is higher than what you receive at your bank, but if you take the money out of the CD before the 18 months is over, you will pay a penalty so you don’t get all your money back.
8. Buy it — if it’s easy to purchase. If you can’t buy it easily through a brokerage firm, online trading account, or insurance company, reconsider your investment.
That’s often a red flag for a scam or an investment that will be difficult to change.
Example: your advisor, Myrnie Paidoff, tells you about a great investment that only she can get you into, because it’s only for special investors. You can’t find any offering documents about it, but she tells you that she can guarantee double-digit returns for you. Correctly, you decide to avoid investing with her.
Adapted for Medium from Chapter Thirteen of From Zero to $avvy: A Quick Guide to Investing by Jennifer Jank.