How Do I Know Which Stock or Mutual Fund to Invest In?

Asking which stock or mutual fund you should invest in is like asking which road you should take. The answer depends on where you are now and where you want to end up. Even if you determine which stock or mutual fund you want to buy, investing is a lot like driving down that road without a radio to update you on traffic conditions. There are likely to be potholes, accidents and detours along the way, so you need to be prepared to make adjustments as necessary.

Determine your current financial status by creating a net worth statement and a cash flow statement. Use a computer spreadsheet, or just divide a sheet of paper in half to create a two-column form. In one column list all of your assets, and total the column. In the other column list all of your debts, and total that column. Subtract your debts from your assets. Whatever is left is your net worth. Create another two-column form. In one column list all of your monthly income from all sources, and total the column. In the other column list all of your monthly obligations, such as your mortgage or rent, utilities, student loans, credit card payments and living expenses; total that column. Subtract your obligations from your income. Whatever is left is your monthly cash flow. Your net worth and your cash flow will tell you how much you have available to invest.

Decide on your financial goals. There is no right or wrong answer, because everyone's goals are different. Your goal might be to create a large enough portfolio to be able to retire comfortably when you reach age 63. Your next-door neighbor's goal might be to create a financial empire and never retire. The couple across the street might want to just save enough to put Junior through college. Once you know what your financial goals are, you can begin to invest toward them.

Acknowledge your level of risk tolerance or aversion. This step is all about your gut reactions. If you'd rather eat glass than watch your money grow slowly but securely in a bank certificate of deposit, you might have a high tolerance for risk. If the thought of your 401k losing money keeps you awake at night, you might be risk averse. Knowing your level of risk tolerance shouldn't make you a slave to your impulses, but it will help you make investment decisions you can live with.

Research your options. While plenty of advice is available from major print and online financial publications, you can get your information straight from the pros. Contact the investor relations department of any company whose stock you are considering and request annual and quarterly reports. Contact the investor relations department of any mutual fund you are interested in and request a prospectus. Read these documents and publications carefully. They will tell you about the company's or mutual fund's current earnings and earnings history. You can learn about management and its philosophy, objectives, costs of doing business and projections for the future. Decide on the stocks or mutual funds that best match your goals and level of risk tolerance.