The questions you ask have a major affect on how successful you become. This is especially true when it comes to investing success. Here are the five questions successful investors ask before, during, and after they invest that helps them create the kind of financial future they want. You can “borrow” these questions from their playbook. If you do, you’ll notice a vastly improved result very quickly.
1. What is my real time frame for this money?
Too often, investors jump into an investment without considering if there is a time-frame match. For example, let’s say you have $5,000 to invest in your retirement account. You have a lot of options. You could use an automated service such as Betterment or you could plunk it all down on Facebook. And there are a thousand alternatives in between. Which way should you go?
Of course, it would be inappropriate for me to tout one particular investment in this post. But I can tell you that if your IRA is your long-term money (and it should be) you should find the best long-term investments that suit your needs.
People often take long-term money and speculate with short-term bets. The problem with this approach is that it exposes you to too much risk unnecessarily. Of course, one or two bets may work out, but if you do this long enough, you’ll end up on the short end of the stick. Match your investments with your time horizon. You’ll be much happier if you do.
2. Can I afford to keep this money invested?
This question takes the “time frame” question much deeper. It really asks if you have enough short-term liquidity such that you won’t have to liquidate this investment prematurely. Too often, people make good long-term investments but disrupt them and liquidate them because they didn’t have enough money in the bank to pay the bills.
The way to make sure this never happens is to track your spending. Get a sense of how much money you need to keep liquid --even for those unforeseen emergencies. This way, you’ll be able to make smart investments and hold on o them.
3. Is this investment consistent with my most important goals in life?
Let’s assume that your most important financial goal right now is to get out of credit card debt and that you owe $5,000 on your bill. Further assume that you just got a $5,000 gift from your Aunt Sally. And your luck didn’t stop there. You also got a lucky tip on a stock from your Uncle Jack.
While you are tempted to take the plunge on that stock, the smart thing to do is focus your resources to achieve your most important goals first. If that includes getting out of debt, that’s where that $5,000 should go --no matter how good that hot stock tip is you got from your Uncle. The same approach should be used if you are deciding to invest or pay off your mortgage. If being mortgage-free is your ultimate goal, you already know what to do.
4. Do I understand the pros and cons of this investment?
Before investing a dime, make sure you understand the potential for loss. This is where it really pays off to be a pessimist. Get clear on the worst-case scenario and make sure you are comfortable with that potential outcome. If you aren’t, don’t make the investment. People who fail to take this step often become emotional when they start to lose money. As a result, they often pull out at the very worst time possible.
On the other hand, if you understand the possible downsides and are comfortable, you’ll be able to hold on during the rough patches. And the ability to stick with your investment strategy through thick and thin is one of the most important foundations upon which investment success is built.
5. What is my exit strategy?
Before buying any investment, know what will have to happen in order for you to sell. This rule is good for traders, and it is also good for people who “buy and hold.” The reason this question is so important is because those who don’t have a clear exit strategy before they buy become victims of their own emotions all too often.
Having a well-articulated exit strategy before you buy will help you survive those emotional times when things aren’t working out.
While I do not advocate a “buy and hold” strategy for most people, my experience tells me that relying on emotions to make investment decisions is always a recipe for disaster. By asking yourself these five questions before you invest--and making sure you have five clear answers--you’ll make smarter investments and you’ll achieve greater financial success.
What other questions do you ask yourself before you invest? What questions do you wish you’d have asked yourself in the past?
Neal Frankle is a certified financial planner in Los Angeles and also owns www.WealthPilgrim.com, a top-notch personal finance blog.