When it comes to investing in the stock market, it can be very intimidating to know where to start. Between knowing how much to invest, what brokerage platform to use, or what type of account to open, there are a lot of questions to ask yourself before buying a stock.
There are a few vital steps you should take before investing any money in the stock market. These include reviewing your current spending, defining your goals, understanding your risk tolerance, and choosing an investment strategy.
Here are the steps to take before investing in the stock market:
Review your current spending
One of the most overlooked steps in investing is understanding your spending and how much you can afford to invest. After all, the more you invest in the stock market, the less you will have available to spend.
To get started, you should review your current income and expenses to see how much is left over each month (you might also realize that you are spending extra in areas you didn’t realize). If you find that you are actually spending more than you are earning or are just breaking even, then you should first focus on reducing your spending (if possible) and building your savings. If instead, you notice that you have extra money after paying all your bills each month and you have a comfortable emergency fund already saved (3-6 months of expenses), then investing might be a good option for you.
Define your goals
Before ever putting your hard-earned money at risk, you should first ask yourself: What are you investing for? How much do you need and when?
Are you saving for a car that you will need in the next few months? Are you saving for a home that you will want in the next few years? Are you saving for Financial Independence or retirement that you wish to happen before age 50? Having a clear picture of your short-term and long-term goals will help determine how to invest.
If your current car only has a few more months of life left and you know that you will need to buy a replacement car, you might benefit from keeping your money more safe and accessible, like a high-yield savings account. If you are aiming to save up your home down payment in 5 years or less, you might benefit from a more conservative allocation, which has more bonds than stocks. If you are hoping to retire or become work optional within the next 20-30 years, then you might benefit from a more aggressive allocation, which has more stocks than bonds.
Understand your risk tolerance
Once you have a general understanding of how much you can save and what you are saving for, you should determine how much risk you are comfortable with. This tends to be a very personal question and is unique to everyone. Depending on your relationship and history with money, you might be more risk-tolerant or risk-averse.
Risk-tolerant people tend to have a greater appetite for risk (i.e., greater stock allocation) and can stomach large swings in value. Risk-averse people may feel uneasy when it comes to risk and might panic when they see their investments drop in value. There is no right or wrong way to feel, but it is important to understand your tolerance and invest accordingly.
Other factors that can affect your risk tolerance include your age, time horizon, income, and net worth. You should work with a financial planner to help assess your risk tolerance and determine an appropriate investment allocation.
Choose an investment strategy
One of the last decisions to make is how you will be managing your investments. Is your goal to beat the market or just set it and forget it?
Active investing can involve picking individual stocks and buying/ selling to take advantage of short-term price fluctuations. This can sometimes incur significant trading fees and short-term capital gains. The goal here is to beat the market.
Passive investing usually focuses on buying and holding for the long term. This can be done by investing in diversified index funds. The goal here is to participate in the market.
Creating a game plan and asking yourself tough questions are essential to investing effectively. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.