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In recent years there has been an explosion of information about
investing-on business news channels, in magazines and newspapers, and on
the Internet. Having a wealth of information at your fingertips, though,
does not necessarily make you an informed investor. To become an informed
investor, you need to first, take time to set realistic and personal
investment goals and second, examine each financial opportunity you are
considering in light of those goals.
Informed Investors Set Goals
Before you invest, think about your overall financial situation and
establish your investment goals. This is a crucial step, for many of the
decisions you will make later will depend on the goals you set now. Once
you've determined your investment goals, you must decide how much
financial risk you are willing to take to achieve those goals. Different
investments bring different levels of risk. Keep in mind that an
investment offering a higher return usually carries a higher level of
risk than one offering a lower return.
Deciding what you hope to achieve will help you select an investment
to meet your goals. Here are some typical investment goals and types of
investments often used to meet them:
- To achieve long-term growth so that you will have money for your
children's education or for your own retirement, stocks or equity
mutual funds might be suitable choices.
- To meet shorter-term goals like saving for a house, car, or
vacation, you might invest in certificates of deposit (CDs) or money
market mutual funds.
- To earn investment income, so that you can supplement other income,
you might consider investing in bonds, preferred stocks, or bond mutual
funds.
- To minimize taxes, you might consider investing in a tax-advantaged
investment or in a retirement account such as an Individual Retirement
Account (IRA) or a 401(k) plan at work.
A Checklist for Informed Investors
Being an informed investor means taking time to examine each
investment opportunity before you invest. Here's a checklist of questions
to help you make an informed investment decision.
Q. Do I have and have I read written information explaining the
investment?
Securities laws protect investors by requiring companies to give you
the information you need to make decisions. Make sure you get the written
documents, such as a prospectus or offering circular, before you buy.
It's important to review the information on your own. Don't rely on
investment advice from family and friends. They can't evaluate the
investment from your perspective.
Ask questions about anything that you don't understand. Don't be
intimated by jargon-after all, it's your money. If you're buying an
investment directly, ask a professional at that organization; if you're
buying through a financial professional, ask that person. No matter how
basic you may think your questions are, these professionals would rather
answer them before you invest so that you're better prepared for what may
happen after you invest. Do not sign anything that you don't understand.
Q. Does the investment match my goals?
Whether you are investing for long-term growth, investment income, or
other reasons, an investment should match your own financial goals. Ask
yourself how this investment could make money for you and over what
period of time. How does its past performance compare with that of other
investments with the same objective? Would that performance be adequate
to meet your goals? (But keep in mind past performance cannot predict
future results.) Why is this investment appropriate for the specific goal
you've set?
Q. Do I understand the risks involved with the investment?
Every investment involves some element of risk and different types of
investments have different types of risks. You should know what these
risks are and how they match your own risk tolerance profile. Are you
prepared to accept the risks associated with this investment? If you
can't afford the risk, don't take it. But don't opt for the most
conservative investment without considering the risk of inflation. (If
the rate of inflation rises faster than the earnings on your investment,
you will be left with less real purchasing power than when you bought the
investment.) For more information about risk, please see "Investing for
Success: Understanding the Risk & Reward Relationship."
Q. Do I understand the costs involved with the investment?
The fees you pay to buy, maintain, and sell your investment can
significantly affect the returns you get. Common types of investment fees
include transaction fees-which you pay directly-and management fees-which
are deducted before earnings are distributed to you.
Commissions and spreads are examples of transaction fees. You can be
charged a sales commission when you buy or sell stocks, bonds, or some
types of mutual funds from financial professionals. Some financial
professionals, rather than charging commissions, charge fees based on an
hourly rate or a percentage of assets. The spread is the difference
between what you pay for a stock or bond and what the security dealer
pays for it. Management fees represent the ongoing costs of managing a
mutual fund. These expenses are deducted from the fund's earnings.
If you're working with a financial professional, make sure you
understand how and when that person is paid. Do you have any payment
options? What services do you get in exchange for the fees? If you're
investing in a mutual fund, read the fee table at the front of the
prospectus. A higher-cost investment may make more money for you, even
after accounting for the costs you pay, than a lower-cost alternative. Of
course, the opposite may also be true.
Q. How liquid is this investment?
How easily could you sell this investment if you need your money
unexpectedly? Would there be any penalty or charge for doing so? What
would be involved in selling it suddenly?
Q. Is the investment legitimate?
Is this investment registered with the U.S. Securities and Exchange
Commission? How long has the company been in business? How experienced is
its management? If you are working with a financial professional, how
experienced is this person? If you have any doubts about an investment's
legitimacy, check with the appropriate government agency and consult
other trusted information sources. When presented with investment
opportunities that seem to offer much higher returns than other
comparable investments, remember: if it seems too good to be true, it
probably isn't true.
Q. Are my investments diversified?
Investing all your money in a single, undiversified investment is
risky. If the investment fails, you stand to lose everything. Wise
investors allocate, putting their money into a variety of investments or
into one or more diversified mutual funds to assemble a portfolio that
spreads and balances their investment risk. When considering a new
investment, ask how it fits with other investments you're considering or
that you've already made. You may find you need to redistribute some of
your money to bring your investment mix back in line with your original
diversification plan.
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