Business woman looking at wall with a bright question mark

10 Questions to Ask Yourself Before Investing

Don't even think about investing your hard-earned money before you ask yourself these ten questions:

1. What is my investment goal?

The most important question to consider before making any investment is, “What am I trying to accomplish?” Your investments will differ vastly if, for example, you are trying to save money for retirement versus trying to save money for a down payment on a house. So, ask yourself, “Is this investment likely to help me meet my goal?”

2. What is my risk tolerance when investing?

If your investment goal is to make as much money as possible and you can tolerate any risk, then you should “invest” in the Spanish Christmas Lottery. Investing in lotteries, however, almost guarantees you will not reach your investment goal.

There are investments for every level of risk tolerance, from lotteries to FDIC-insured certificates of deposit (CDs). The former yields up to 10,000,000,000% while the latter yield an average of around 2% to 5%, depending on the term. Are you comfortable with the risk you’re taking?

3. What happens if this investment goes to zero?

Of the original stocks in the Dow Jones index in 1896, only General Electric is still a going concern—something to think about if you’re a long-term “buy and hold” investor. The other eleven firms in the original index have either gone bankrupt or have been swallowed up.

There is a real possibility that any investment you make could go to zero while you own it. Ask yourself, “Will I be financially devastated if this investment goes to zero?” If the answer is yes, don’t make that investment.

4. What is my investment time frame?

In general, the longer your investment time frame, the more risk you can accept in your investment portfolio because you have more time to recover from a mistake. Also, if you’re saving for retirement and you’re decades away from retiring, investing in something illiquid (like a rental property) may make sense. But if you may need the money within the next couple of years, your investment should be liquid (stocks, bonds, CDs). Ask yourself, “Does this investment make sense from a timing point of view?”

5. When and why will I sell this investment?

If you know why you are investing in something, you should have a pretty good idea of when you are going to sell it. If you bought a stock because you were expecting 20% revenue growth per year, you should plan on selling the stock if revenue growth doesn’t meet your expectations. If you bought a stock because you liked the dividend yield, sell the stock if the dividend yield falls.

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6. Whom am I investing with?

It is very difficult to judge the character and ability of anyone based on a two-paragraph description available in a company’s annual report or a mutual fund prospectus. No one looked better on paper than Bernard Madoff (of the $50 billion Ponzi scheme). But you should at least know with whom you are trusting your money. Things to look for are long, successful track records and compensation schemes that reward investors.

7. Am I diversified?

Most people should have diversified investments. For example, buying 10 different high-technology companies does not constitute diversification. In addition, your largest asset (unless you are close to retirement) is probably not your house, but the present value of your future paychecks. It is unwise to have investments that will likely drop at the same time that your salary is disappearing. Consider this: “If I am unemployed next year, where will this investment be?”

8. Do I have special knowledge in what I'm investing in?

Peter Lynch, famous for managing the Fidelity Magellan Fund, thinks that ordinary people have a huge advantage over investment professionals in fields where they work because no investment professional will ever know more about an industry than someone who works in it. Ask yourself, “Am I investing in something I know something about, or am I investing in something that two college professors at Yale know something about?”

9. Why do I still own that investment?

It is a good idea to periodically look through your investment portfolio to make sure you still want to own your investments. Selling an investment for a loss or selling a big winner is very difficult. But the biggest difference between amateur and professional investors is that professional investors don’t have emotional entanglements with their investments, and they can divest themselves of an investment without kicking themselves if the investment continues to gain value.

10. Should I be managing my own investments?

Most Americans have to manage their own retirement savings at night and on weekends. It is very difficult for a typical investor to beat highly paid, full-time investment professionals. If you don’t have the time or inclination to manage your own investments, you should consider paying a professional to do it for you. A corollary to this question, however, is, “Are my interests and the interests of my investment advisor aligned?” If the answer to that question is no, find a new investment advisor.