How Much Stock Risk Should You Take?

Choose your risk level to invest in. Decide on how much risk you are willing to take, and on how much risk you are comfortable with. The longer your time horizon, the more risk you should take. The more risk you take, the higher your return should be. When you take risk, make sure you try to diversify within your risk level. For example, if you are investing in medium risk, large cap investments (like Fortune 500 companies or S&P 500 companies), either buy several stocks or buy a mutual fund that invests in a broad array of these companies.

Determine Your Goals and Needs. Depending on what your goals are, you will utilize different investment tools. Here are the first questions to answer. If you are saving for one or more of these goals, then prioritize them and allocate your investment money among the various investments.

Are You investing for the short or medium-term? If so, you’ll want to open a traditional brokerage account, or maybe even use your local bank. If you are investing for the short-term (less than a year), then you are probably best off if you purchase a CD at your local bank or park your money in a money market savings account. If you are investing for the medium-term or long-term, you’ll want to open a brokerage account. Opening a brokerage account is as easy as filling out and mailing in an online form, and can be done by almost anyone.

Are You investing money that you will want access to before retirement? If so, do not invest the money in a tax-deferred account, but rather follow the advice from the previous goal.

Are You Saving for retirement? If so, you’ll want to utilize as many tax-deferred investments as possible, including any 401K, 403B, IRA or Roth IRA that you qualify for. 401K and 403B plans are only available through your employer. These are the most beneficial tax-deferred plans available. If you are eligible for these plans you should start investing in them immediately, and contribute as much as you can each paycheck and each year. The difference between an IRA and a Roth IRA is that an IRA is tax deductible the year that you create it. Also, if you already participate in a 401K or 403B plan, you are usually unable to contribute to a traditional IRA. In a traditional IRA your money grows at a tax-deferred rate but when you sell it you’ll have to pay taxes on the full amount. On the other hand, with a Roth IRA you are taxed on your contribution the year you make the deposit, but you will never have to pay taxes on the money when you take money out. (Click here for a good example of the differences between the two)

Are You saving for children’s college? If this is one of your specific goals, then you can invest money in a 529 plan (either a prepaid tuition plan or a savings plan) or a Coverdell IRA (formerly know as Educational IRA). Also, see collegesavings.org to find out what plans your state offers.

Which Stock Asset Types to Choose

Choose your asset class(es) to invest in. Do you want to buy money market accounts (or CDs), stocks, bonds or real estate. If you have a long term investment horizon (over 15 years), then there is no need to invest in bonds yet. Most investors are best suited to buying stocks. Stocks include individual companies, stock market tracking stocks (like the QQQ or SPiDERs), and of course mutual funds.
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