To borrow a phrase from Kathy Kristof in her book, Investing 101 (first edition):
Investing is not about having more money than God, it's about having the money you need when you need it.
When you start to invest, ask yourself these questions:
- What is the money for?
- How much will I need?
- When will I need it?
These are your guiding principles. Write them down. This will help you determine which instruments — equities (stocks) or equities funds, certificates of deposit, corporate bonds, savings bonds, treasury notes, or what-have-you — you'll use to achieve your goals. They'll also help you understand your risk tolerance.
risk tolerance, I am talking about the ability to withstand downturns — financially, but also emotionally. If that money isn't there when you were planning to use it, what will that mean for you and your family?
You can lose all of your money in the stock market, is a thing my mother loves to say whenever I talk to her about investing. She saves and has a few investments, but she's never been especially thoughtful about growing her money.1 To her, investing is a gamble in which you can lose everything.
That is not how investors think about risk. Risk, to investors, is more about uncertainty.2 With stocks, this refers to the variability of returns over time. For bonds, it's the chance that interest rates will change, or that the debtor won't repay the bond.
investment in which you can lose all of your money is a fool's venture that's isn't worth your money.
An investment that loses 20 percent one year, but gains six percent each year for the next five years is still one that grows over time. That money may not be there when you want it to be, but it will get there over time.
Investing 101 has an excellent chapter about risk, plus a worksheet to help you determine your risk tolerance. I own both editions of the book. It's one that I return to often to keep myself grounded and on track. I have a bit of a gambler's mentality when it comes to stocks. Her book helps me curb that tendency.
Again: answer those three questions. They're key to formulating your savings and investment strategy.