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Most would-be investors want to know where to start when when they begin to think about investing. These 5 questions can help you to make better investment decisions.
1. Can You Describe This Investment?
Your financial advisor or the person pushing you towards an investment should be able to describe the investment very clearly in just a few sentences. You should understand what the investment buys and sells, how frequently it trades or invests, and how much the investment expects to make.
You should be able to understand the basics of a possible investment in just a few minutes. If you don’t understand it, that’s a red flag that perhaps the person recommending it doesn’t “get it,” or that it’s a dog.
Here’s an example with a sample product, an ETF Trade Signal Subscription Plan. Trade Signals are where you buy the exact trades of a system, where you get exactly what to buy or sell according to a proprietary system. Our sample ETF product trades popular Exchange Traded Funds (ETFs) once per month. The claims of this program is that it beats the stock market over a period of years and works by avoiding the worst months of the U.S. stock market by being invested in other assets during these bad times.
This product sounds pretty good, right? But if you are considering getting this, make sure you understand what all the claims mean first. If you don’t understand something, whether it’s about one of our products or your cousin’s friend’s new tech startup, make sure you understand the basics first. If you don’t get it, ask questions until you do. If the person selling it doesn’t understand it enough to tell you why it’s a good investment, chances are it isn’t.
2. How Risky Is the Investment?
Every investment has risk. There are no risk free investments. Some investments are more risky than others, but every investment has risk. There really is no such thing as a sure bet and anyone who tells you there is, is lying.
Investments should match your risk tolerance. You need to be clear about how much risk you are willing to take in your trading and investing. This is not an easy question to answer.
In general, people overestimate the amount of risk they are willing to face, and underestimate the risks they are taking. Here are a few good rules of thumb:
As you grow older, take less risk. As your net worth increases, take less risk. Most people think buy and hold strategies are the least risky strategy available. They are wrong. Buy and hold exposes investors to massive swings in the valuation of stock market.
For example, let’s look at the risk claims for our sample product: ETF system was created to reduce the amount of risk for investors. The biggest losses over the last 5 years have been under 15% in our system, while the stock market overall has lost over 50% at least one time, and over 20% several times. That would be a really good level of risk and the product would be a worthwhile investment. Many of the products sold online don’t even mention risk. This should be an automatic red flag that the person selling the product doesn’t quite care as much about your money as you do.
Keep in mind that past performance does not guarantee future results for any investment.
3. What Are the Returns and Costs of the Investment?
Returns! Everybody wants to know how much money they are going to make when they make an investment. It’s the first thing most people look at when they think about investing in a product or fund.
This is a very dangerous way to invest. The returns of every investment should be judged against the risks and the costs of the investment. High returns usually mean high risk, and high fees too.
High returns usually mean high risk, and high fees too. High fees are the biggest reason for low returns. Many investment programs can make money, but overcoming fees is difficult. Choose investment programs with lower fees, and you’ll usually make more money.
Stock market investing has become incredibly expensive over the last few years. The costs for simple 401k accounts are so high the government will require all the fees to be easy to find and calculate starting in July of this year.
Many brokers offer commission free trading on selected ETFs. If you are in the stock market, look for products that use commission-free ETFs to avoid high fees.
Once you “get” the information that someone is trying to sell you, then it’s time to do the math. The best thing about math is that it’s purely factual, no room for opinion. The numbers speak for themselves.
In the case of our sample ETF system, the costs to purchase the system is $350 per year, or $35 per month. The costs to trade the system (brokerage and trading fees based on the description of how much and how often the system trades) should come out to be under $1000 per year. The returns of the system are solid. Over the last 5 years, the system has just over 16% per year returns. Do the math and determine if the system works for you.
4. What are Credentials and History of the Advisor?
Investment advisors have different levels of credentials and history. Credentials are no guarantee of quality, but they do help. Also, serious advisors tend to take their resume and credentials very seriously.
Look for the history of the investment manager, and their credentials. The investment business is built on trust, so look for mangers concerned about their reputation and their clients.
5. How Do I Get My Money?
This is an important question. How can you “cash out” of the investment. Many investments, like real estate, are not easy to sell. The investment might make money, but if it takes 3 years to sell, then the investment may not be liquid enough for your tastes.
Some investments can be tied up with the investment manager. Hedge funds and some investment pools take up to a year to get the money out of the account.
In some products, however, you have complete control over your funds. All you need to do is sell the stocks, and your money is available.
Overall, you should have answers to all of these questions and feel comfortable with all of these answers, before you can even think about investing in something. No matter how good an investment may sound, the numbers are really at the root of the equation and numbers never lie. Do the math and you should be on the right track.