5 Simple Questions to Ask Before Investing in Anything

5 Simple Questions to Ask Before Investing in Anything

Photo courtesy of Arman Dz.

Investing can be an intimidating topic for many people. It’s a world filled with unfamiliar terms and an almost limitless supply of options. We’re bombarded regularly with conflicting advice about the best strategies, the best investments, and the next “cant miss” opportunity. It can be difficult to tune out all the noise and focus on what truly matters.

Even when we already have an investment plan set up and running, we’re often presented with new investment opportunities that can seem pretty enticing. So how do we evaluate whether these new opportunities are right for us? We have to look beyond the hype and focus only on the aspects of the investment opportunity that are important to our specific situation. So today I’d like to talk about the five questions I think we all need to ask before deciding to put our money in any particular investment.

1. How does it fit with my overall investment plan?

This is really the overarching question that all of the questions below help to answer. Before putting your money into any single investment, you should have an investment plan that at the very least specifies a few key things:

No investment decision should be viewed in isolation. You aren’t just buying a stock, or a bond, or a mutual fund, or whatever. You’re buying an additional piece of your overall investment portfolio. An investment that looks good on its own may not be a good decision for you because it doesn’t fit well with your other investments. The opposite could also be true, where an unappealing investment for one person could be perfect for another.

To give you an example from my own personal investment plan, I choose to keep the bond portion of my investments in US government-issued Treasury bonds as opposed to bonds issued by companies that would give me a higher interest rate. I willingly choose a lower-returning investment because it fits better with my overarching goal of using stocks to provide my long-term returns and bonds to protect me during the periods when stocks falter. Treasury bonds serve my specific purpose better than other bonds, so they’re the better choice for me when considered within the context of my overall investment plan.

2. Do I understand it?

If you can’t understand how something works, you shouldn’t invest in it. There are several reasons for this, chief among them that if you don’t know how a particular investment works, you can’t properly evaluate your answer to Question #1. How can you understand whether it helps you reach your goals if you don’t even know how it’s supposed to work?

Bad products are often sold to consumers on the faulty logic that sophisticated investing has to be complicated and therefore above the comprehension of the average person. I once had a life insurance salesman explain the benefits of whole life insurance as an investment by showing me his watch that he had apparently just bought and saying he didn’t know how it worked, he just knew that it worked. Wow! Sounds great! Sign me up!

Look, the best investment strategies are simple. They’re not the best because they’re simple, they’re just objectively the best and it’s a nice benefit that they’re also simple. If you’re new to investing you will have to do a little bit of learning to understand your various options and how they work. But there’s nothing worth investing in that you can’t come to understand.

3. What is the investment’s track record?

It’s important to understand the history of a particular investment so you can have some idea how it will behave in different environments. How will it act during economic booms? How will it act during a recession? How will it be affected by inflation? All of these questions help you get closer to your answer to Question #1. Ideally, you’d like your investment portfolio to have a few different investments that behave differently in different conditions. That way no matter what’s going on in the world, at least part of your portfolio will be performing well.

There are some big warnings that come with this question. The first is the generic advice that past performance is no guarantee of future results. There is no crystal ball here. We cannot predict the future. The best we can do is identify consistent trends from the past and apply them prudently in our plans going forward.

It’s also important to recognize that the more specific you get, the less reliable past performance is. As an example, you can get a decent sense of how the stock market as a whole should behave in different kinds of economic conditions, but things get much murkier when looking at any specific stock.

Finally, be very aware of how much history the investment has. A 10-year track record is actually not very much time at all. Even the stock market, for which we have data for over 100 years, still shows us behavior we’ve never seen before. That doesn’t mean you should automatically avoid anything new, but it does mean you should be extremely cautious and know that you are taking on extra risk when investing in something without a long history.

4. What are the costs?

Studies show that cost is actually the single best predictor of future investment performance. Morningstar even found that cost predicted the future performance of mutual funds better than their own widely-used star rating system.

With that in mind, you should be acutely aware of the various costs associated with whatever investment you’re considering. Mutual funds have one potential set of fees, but other types of investments will differ. These fees should be very transparent, and if they’re not you should be wary of both what is being offered and who it is offering it to you. Remember that returns are never guaranteed, but fees usually are.

5. How easily can I get out of it?

Successful long-term investors are people who craft a well thought out plan and stay consistent with it through the ups and downs of the market. They are not people who try to move in and out of different parts of the market based on current conditions or predictions about the future. That kind of constant activity is a recipe for failure.

With that said, not every decision you make will be a good one and you need to know what your options will be for changing your mind if you decide it makes sense to do so. You should be able to get out of any investment quickly and with little cost. As an example, a good mutual fund will allow you to sell out of it by the end of any given day and will cost you nothing more than the cost of a typical trade (if that) to do so. You may have lost money on the investment, but there’s no extra cost for deciding to get out.

On the opposite end of the spectrum, one of the reasons I consider whole life insurance to be a bad investment is that it’s typically very costly to cancel the policy. Certain mutual funds are also costly to sell, as they charge something called a redemption fee, which is essentially a percent of your investment that goes to the investment company if you decide to sell. With other types of investments, you may not even have the option of getting your money back before a certain amount of time has passed. All of these things that make it more difficult to get out of the investment should make you think a little bit harder before getting in.

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44 Comments... Read them below or add one of your own
  • DC @ Young Adult Money September 18, 2013

    Great tips, Matt. I think “do I understand it?” and “how easily can I get out of it?” are really important questions to ask. If you are investing in shoe companies but know nothing about what brands are popular (and why), how the business works, etc. you should take a step back. I think investments that are harder to get out of sometimes pose better returns – i.e. small business ownership that may take some effort to sell your share of the company, but there is something to be said for looking for liquid investments.

    • Matt @ momanddadmoney September 19, 2013

      There are definitely certain investments without an easy exit that can be worthwhile, such as your example of starting a business. Clearly that’s one of the best routes towards huge wealth generation. But it’s important to know the inherent risk going in. It doesn’t mean it wouldn’t be worthwhile, it just means you have to understand the realities of what you’re getting into.

  • Kali @ Common Sense Millennial September 18, 2013

    These are excellent tips! Great things to have in mind if you’re new to making investment decisions – and actually, if you’ve had a bit of experience I imagine these are just as important to go over, at least from time to time, to make sure you’re still making good decisions with your money. Thanks for sharing!

    • Matt @ momanddadmoney September 19, 2013

      Completely agree. I think they’re worthwhile questions for everyone, new or experienced, to consider. Nothing remains static so the answers to these questions at one point in time may no longer apply down the road. Best to stay on top of things and re-evaluate on a regular basis.

  • Martin September 18, 2013

    You really have to understand what’s going on. If you don’t then why bother

  • Grayson @ Debt Roundup September 18, 2013

    Great questions Matt. The best one I think is Do I understand it? That is extremely important and one reason why I wanted to research things before I jumped in. Knowing what you are investing in is a great tip.

    • Matt @ momanddadmoney September 19, 2013

      I definitely think that’s a really important one. It’s not worth jumping headlong into something you don’t understand, no matter how great someone else tells you it is. Investing is as much about behavioral discipline as it is about technical skill (I would actually say more), and not understanding something is a quick route towards messing up that behavioral aspect.

  • John S @ Frugal Rules September 18, 2013

    Great tips Matt! These are such vital questions to ask yourself and the sad reality is that so many do not do it and pay for it as a result. I saw it every day for years and it always pained me to no end to see investors make mistakes that could easily be avoided with a few questions. I think all of them are vital, but I really think many need to start looking at #1 & #2. If you don’t have those, then the others will be off.

    • Matt @ momanddadmoney September 19, 2013

      Thanks John. I agree that Questions 1 and 2 are the priority. Understanding exactly how something does or doesn’t fit into your overall plan is really the key to using it well.

  • Kim@Eyesonthedollar September 18, 2013

    I think not understanding is a huge reason why some people never invest. If we spend a fraction of the time studying investments as we did watching reality TV, I think the nation’s financial situation would be tons better.

    • Matt @ momanddadmoney September 19, 2013

      Haha, but reality TV is just so gripping! I completely agree though. I do understand that it can be intimidating to start learning from scratch. It’s an unfamiliar world for many with a lot of big and frightening terms. But it’s just such an important part of securing your financial future and even just a little bit of learning can really go a long way.

  • Ree Klein September 18, 2013

    I’m crazy about your blog, Matt! You have such a level head and a great writing style, which makes your content easily consumed by all.

    I love this line in today’s post: “Remember that returns are never guaranteed, but fees usually are.”


    • Matt @ momanddadmoney September 19, 2013

      Thanks for the kind words Ree! That point about fees is so important. It’s counter-intuitive, but it’s rarely a good decision to pay more for your investments. As John Bogle once said: “In investing, you get what you don’t pay for.”

  • Shannon Ryan September 18, 2013

    Excellent post, Matt. So many people rush into investing and their only homework is to follow whatever everyone else is doing. For a few lucky people that might work but for most of us that is a recipe for disaster. While many of us may have similar goals, retirement, buy a home, etc., that doesn’t mean our plan or investments should necessarily mirror one another. These are great questions that I suspect many investors cannot answer. As they say, knowledge is power. πŸ™‚ And feeling good about your investments and investment strategy is powerful indeed.

    • Matt @ momanddadmoney September 19, 2013

      We definitely have a lot of the same goals, but our timelines are different, our risk tolerance is different, and the amount of money we need for those goals or have available to save is different. So like you say, our plans cannot simply mirror one another and what works for one person might not work for another. I think that taking the time to answer these questions is the way to make sure you end up with a plan that works for you.

  • Pretired Nick September 18, 2013

    Thanks for articulating these points. Very relevant to me right now!

  • Andrew September 18, 2013

    Very important questions to ask…costs are definitely important to keep low. So I stick with mainly index funds. And as for ease of getting out…great point with whole life insurance. I know those surrender charges are pretty steep. That’s why I’m glad I did get stuck buying one years back.

    • Matt @ momanddadmoney September 19, 2013

      Thanks Andrew. Cost is one of those things that people sometimes roll their eyes over, but it really matters.

  • Done by Forty September 18, 2013

    Man, where was this post when my wife and I first got into investing? πŸ˜‰

    Yet another great lesson that it’s better to spend your time performing common sense due diligence than to act quickly, trying to jump on an investment at the right time. I like the first tip the most: how does an investment fit within my overall plan? AA is vitally important and without understanding how a new investment fits (or if it fits) within your asset allocation, you’re potentially messing with the balance in a bad, bad way.

    • Matt @ momanddadmoney September 19, 2013

      It always frustrates me when people tout the merits of a particular investment in a vacuum. Investing is a lot like building a basketball or football team. You can’t just throw the best players (or highest-returning) investments together and think that’s enough. The pieces have to fit well together and be working towards a common purpose.

      • Done by Forty September 19, 2013

        A sports analogy to explain investing principles? You get me, Matt.

  • moneystepper September 18, 2013

    Great tips Matt. I specifically like number 2. When making a new investment, I always make sure that I can explain it in such a way that I would independently convince myself I was listening to me!

    Therefore, for a share investment, I need to do all the sums, all the ratios, understand the BS and P&L, know the management records, NPV calculations, etc etc….

    • Matt @ momanddadmoney September 19, 2013

      “I always make sure that I can explain it in such a way that I would independently convince myself I was listening to me!” I like that strategy. If you can’t clearly articulate your reasons for investing in something, you probably shouldn’t be investing in it.

  • Pauline @RFIndependence September 19, 2013

    yep, definitely invest in something you understand. Some people prefer stocks, other real estate, or something else, but if you become good at it you can diversify within your class of assets and build a nice portfolio.

  • Pauline @RFIndependence September 19, 2013

    Whatever the asset class, you have to understand what you do. I am more comfortable with real estate than stocks and diversify within the class because I understand it more. I also ask “what if I lose it all?” which can happen even if you had a plan.

    • Matt @ momanddadmoney September 19, 2013

      I think that sticking with what you know is a good strategy, as long as you make the effort to stay truly diversified and not hinge everything on just a couple investments. And I think your question about losing it all is a really good one. Knowing what you really have at risk and how you would handle things if that risk came about is really important. It’s very easy to get caught up in the excitement of the upside of an investment only to be caught off-guard by the reality of the downside.

  • Laurie @thefrugalfarmer September 19, 2013

    Love these tips, Matt. Another question I would ask is “Can I afford to lose it all?” I think sometimes people focus on what a “sure deal” it is, and don’t ask questions like the ones mentioned above. They want to see their investment opportunities through rose-colored glasses, you know?

    • Matt @ momanddadmoney September 19, 2013

      I totally agree Laurie. As I responded to Pauline, understanding the true risks involved is incredibly important. If you go into investing expecting never-ending positive returns, you’re probably going to react incorrectly when the inevitable negative returns show up. You have to know the downside risk and have a plan for how to react when it shows up. Great addition Laurie!

  • Suburban Finance September 19, 2013

    I agree – great points. Knowing the companies you invest in is definitely under-rated.

  • Alexa Mason September 19, 2013

    This is the perfect advice for me. I feel like I know nothing about investing. There are certain concepts I understand but for the most part everything is over my head.

    • Matt @ momanddadmoney September 19, 2013

      It takes a little bit of time to learn, but the good news is that you can invest very simply and very effectively at the same time. So you don’t have to feel like you need a PhD to be successful.

  • AvgJoeMoney September 19, 2013

    That’s the most incredibly bad life insurance sales pitch I’ve ever read or heard. It’s incredible that someone would use that analogy…..sign me up indeed.

    • Matt @ momanddadmoney September 19, 2013

      I know right? I was kind of shocked in the moment. Needless to say I did not do any business with him.

  • Charles@Gettingarichlife September 19, 2013

    Liquidity and carrying cost are very important in investments. People were buying actual gold and don’t realize that they lost half their money because they bought at retail and dealers only buy at wholesale. Physical gold isn’t easy to sell for a good value. 90% of investors should stick to the keep it simple stupid method which is index funds, cds and savings accounts.

    • Matt @ momanddadmoney September 19, 2013

      I just don’t understand the appeal of gold. I mean, I know the reasons people give for investing in it, I just don’t personally feel like they’re very good reasons.

  • Kyle James September 20, 2013

    I like this. If I ask myself “Do I understand It?” it would definitely force me to do my research before investing. Interestingly, this carries over to almost anything in life.

    • Matt @ momanddadmoney September 20, 2013

      Good point. I think applying it to other parts of your life can definitely be beneficial.

  • MoneySmartGuides September 22, 2013

    The best investment strategies really are simple. When you are researching an investment and it’s super complex and difficult to understand, I recommend you question it and do thorough research on it. Many times the increased complexity is there to get the investor confused from realizing what is really going on. Many times, this signals a scam.

    • Matt @ momanddadmoney September 23, 2013

      I think you’re spot on. There’s really no need, and often a danger, in investing in something you can’t understand.

  • Bruce Willis October 10, 2013

    hahahah awesome questions. everyone need to know. I’ll keep that in my mind for sure.

  • Andrew January 22, 2015

    Have you ever watched the show shark tank?
    Something bothers me.. they make deals for a % of the company, the owners invest that money to help the business grow. Now they have that same % in a more valuable company. Doesn’t seem fair?
    Like I will give you 200k for 20% of your company worth 1 million. Now that money goes into the bank and business now worth 1.2million. My 20% now worth 240k. Am I missing something?

    • Matt Becker January 22, 2015

      Hey Andrew. I have watched Shark Tank (my parents love it), though I’ll say that I’m not well versed in the venture capital world. Still, I can give your question a shot.

      Basically, the value of the company doesn’t really change once the person invests. A company with a valuation of $1 million doesn’t necessarily have $1 million in the bank. Instead, it’s an estimate of what that company would sell for today. So that estimate doesn’t automatically move once you have an investor, and therefore the investor’s money isn’t automatically worth more as soon as they invest.

      Does that make sense?

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