The investment choices you make depend on your personal situation. Before you invest, you need to consider your goals, time frame, current assets and risk tolerance.
What are your goals and objectives?
The first step in developing a solid savings and investment plan is to decide what you want your money to do for you. When you think about your financial goals, it's important to be as specific as you can. That's because choosing an investment without a specific goal in mind is a little like packing for a vacation before you know whether you're going to Alaska or Hawaii.
Start by making a simple list of all your financial goals. By identifying and prioritizing your goals - such as buying a new home, paying college tuition for your children, and funding a comfortable retirement - you can help ensure that the investments you select are appropriate to achieve your goals.
How much time do you have?
Next, consider your time frame - in other words, how long do you have until you'll need your money? Setting time frames for each of your goals is key because it can help determine how long your money can be working for you. Some of your goals, like saving for a vacation, may be short-term and less than four years away. Others, such as funding college or saving for retirement, may be longer-term and more than 10 years away. That's why it's important to remember that an investment which may be appropriate in helping you achieve a longer-term goal may not work as effectively for those that are shorter-term. Determining a time frame for each of your goals will guide you as you select your investment options.
How much money do you have?
Before you make any decisions about investing, you need to assess where you are currently relative to where you want to be. Begin by taking a "financial inventory" to determine how much money you have to invest and how your other assets are already allocated. Remember, your total financial situation may dictate a more conservative or aggressive strategy and is a key factor in influencing the types of investments that are most appropriate for reaching each of your goals.
How much money do you need?
Quantifying your financial goals - in other words, determining how much money you'll need in the future - is important because it can help determine how much money you'll need to put aside now to accomplish your goals. The type of investment you select and your time frame will substantially impact the amount of money you'll need to begin saving for your goal.
What kind of investor are you?
Along with determining your financial goals and your time frame, you'll want to also consider what type of investor you are - in other words, what is your risk tolerance? No matter what type of investment you select, there are certain risks and potential rewards associated with it. Depending on the amount of time you have until you need your money, some of those risks may be more acceptable than others. If you're like many investors, you may invest more conservatively for your shorter-term goals and more aggressively when your goals are farther into the future.
Putting it all together
Choosing just the right investments to reach your many goals, all with different time frames and all requiring significant amounts of money to achieve, can seem like a daunting task, especially since the factors influencing your investments and their success are constantly changing over time. Asset allocation - the process of dividing your money among different types of investments - has proven to be an effective strategy to successful investing.
Finding the right investment mix of stock, bond and money market funds can help assure that your portfolio provides the potential to meet all of your short-term and long-term financial goals throughout a lifetime of investing.
Asset allocation can also reduce the volatility of your portfolio and help manage your risk. That's because when you diversify your investments, your financial security isn't tied entirely to the ups and downs of just one investment. Periodic rebalancing of your portfolio will help ensure that you have enough cash on hand to meet short-term needs without disturbing your longer-term stock and bond investments.