4 Questions to Ask Yourself Before You Buy

A few months ago, your neighbour told you about a hot new stock he bought. Last week, a colleague told you she just bought a similar one. And yesterday, your brother told you he's jumped in, too.

You're probably wondering by now why YOU haven't done the same. It's hard to avoid the hype about certain hot stocks or sectors. They're often volatile, which is why you hear about them almost daily on business news reports.

Hot investments are a good conversation-starter for momentum investing. Momentum investors look for stocks that have strong upward (or downward) price trends. But like with all investing decisions, if you're thinking about getting a piece of the action on stocks showing momentum in either direction, there are a few key questions you should consider.

1. How comfortable am I with risk?

You would have answered this when you began your investing journey, but it's always a good question to revisit. If you're a fairly conservative investor and now you're considering an investment that doesn't fit that profile, make sure you're doing it for the right reasons. Just because it seems like everyone (and their brother) is putting money in a high-growth sector or volatile stock, it still has to be the right strategy for you.

2. How long have I got left to invest?

If you have a longer-term time horizon, you're likely already pretty good at ignoring the day-to-day volatility of the markets. What you want to avoid is making an investment decision and then getting spooked a few days later when those wild swings end up going in the opposite direction of what you had hoped. If you believe in the long-term potential of a company, you need to remind yourself that your goal wasn't just to make a quick buck. (Unless of course your goal is to put that "extra money" into the market hoping to profit from a short-term trade. Just remember that the market swings both ways.)

3. Have I done my homework?

Research is an important part of investing, no matter what your level of sophistication. You wouldn't buy a car without giving it a test drive, and most people these days wouldn't book a hotel room before reading a few online reviews. Similarly, it wouldn't make sense to make an investment based only on the fact that's it's a hot sector. Not all stocks are created equal and the quality will vary within a sector – even the trendy ones. Dig deeper to make sure you know what a particular investment is all about.

4. Am I diversified?

Diversification can help mitigate risk in your portfolio. Take a look at your overall mix of assets – cash, fixed income and equities – and determine where this new investment idea fits. Will it change your ideal mix or risk profile? The answers can give you additional insight into whether it's an investment that suits you.

Trends come and go, from food to fashion to investing. But picking investments is (and should be) more complicated than simply searching for the next hot seasonal colour. Risk is an inherent part of investing, but understanding those risks is incredibly important in helping you reach your investing goals.

**This article was updated on November 10, 2020.