5 Ways New Investors Can Reduce Stress

Investing can be a scary endeavor for first-timers. In today’s world, there are many resources that can influence an investor’s decision-making, either for better or worse. You can drastically reduce the stress that comes with first-time investing by simply educating yourself and developing a financial plan.

One of the biggest obstacles for beginning investors is a fear of the unknown. This fear often causes first-time investors to abandon their original motives for investing and make decisions based on emotion. Developing a proper financial plan can help you develop an investment goal while keeping you on track when the times are tough.

1. Develop a Budget

The first thing to do before investing is to create a budget. Begin by carefully tracking all expenses on a monthly basis. Once this is established, compare expenses against all income sources. Look for large future expenditures, like an annual tax bill or membership dues. After a budget is created, the next step is to establish an emergency cash reserve of three to six months of expenses. Only from this reserve can you take any surplus money and earmark that toward any type of investment. Having the extra cash cushion for expenses will help reduce financial stress and keep the money invested for the long term.

Outside of a home mortgage or low-interest auto loan, your focus should be on reducing debt balances prior to investing. Credit cards or unsecured personal loans often carry high APR interest payments, and paying these off should be a priority over investing.

2. Understand Investment Risk

Potential investors should be fully aware of the different types of investment risk and how they relate to a specific time horizon. Personal risk tolerance is extremely important when selecting investments, as well. For example, speculative investments are a poor choice for investors who are uncomfortable with losses. Additionally, understanding the correlation between risk and potential return is important. Higher-returning investments generally carry more downside risk. For example, a bank certificate of deposit offers virtually no risk to principle, but has a low interest payment. A growth stock may have the potential for double-digit returns, but losses can hit double digits, as well.

3. Determine the Proper Investment Account

Determine the ultimate goal behind investing, whether it is to help fund retirement or to save for a child’s education. This has a great effect on both time horizon and liquidity needs. A younger adult saving for retirement has a 20- to 30-year time horizon. An appropriate investment account in this case may be an IRA or 401k that offers tax-deferred growth. These types of accounts work because the investment is meant to be long term, and there is no immediate need for liquidity.

If you are looking to withdraw money after only a few years, consider a taxable account where the IRS does not penalize withdrawals made prior to age 59 and one-half. Although there is no tax advantage in this type of account, it allows you to convert the investment into cash. Determining the proper time horizon and need for liquidity is important when deciding what type of investment account to use.

4. Proper Investment Selection and Diversification

Once the proper account type is set up, choosing the correct investments is the next step. Conduct thorough research through companies like Morningstar or by using analyst research reports when determining which investments are a potential fit. The investments should align with both your investment risk preferences and liquidity needs. Stocks and bonds are generally liquid, with funds being available after a three-day settlement. Annuities and non-publicly traded investments are not liquid and often have long lock-up periods or large penalties to exit early.

When selecting investments, be sure to properly diversify among many asset classes and sectors, as this often reduces risk while increasing overall return. Mutual funds or ETFs are a great way to get instant diversification, but remember that they carry an extra yearly cost. Even though some individual stocks may have excellent track records, there is significantly more downside risk to only owning one or a few in your portfolio. Consider all of your investments in unison, and be sure that they both match your risk tolerance and will help achieve your investment goals.

5. Create and Monitor a Financial Plan

The final step is to create a financial plan with the information from the prior four steps. Investing is extremely emotional for most people, especially if they are managing their own money. Life changes with time, and looking at a financial plan can help you make appropriate changes or stay the course. When the stock market goes through volatility, an investor can refer back to a financial plan to remember the long-term goal and stay the course. Making emotional decisions or attempting to time the market can have a negative effect on the long-term return of your investment portfolio, so it is important to refer to a financial plan to avoid these potential mistakes.