Like most people will agree, investing is the best way to wealth is it is done the right way. As beginners trying to put their money in the right place, one thing they lack is experience, and it might cost them a lot before they get it right.
However, gaining these experiences does not have to cost you valuable time and money as the internet provides a lot of advice and suggests the best methods to go about investing. This article contains some of these suggestions
- What are 10 Things you Need to Know before Investing?
- Top 10 Ways to Start Investing Without Knowing Anything
- What are Some Tips for Beginner Investors
What are 10 Things you Need to Know before Investing?
Not everyone is in a financial situation where it makes sense to invest in anything riskier than a savings account or a ready-made retirement plan.
Read Also: Investing for Retirement: The Complete Guide
People simply see the numbers that a rising stock market is putting out and want to throw all their money in, or else they hear some apocalyptic wannabe guru telling them to invest in gold and they’re ready to start putting their money down. Often, these are people who aren’t financially ready to invest and don’t have the mindset or the knowledge to make it work.
Make no mistake about it, though: The groundwork needed for investing is something that anyone can achieve with some time and effort. It just takes a little time, a little learning, and a little bit of self-evaluation.
Here are 10 things that you really should do before you even consider investing in anything beyond your savings account or your retirement plan.
1. Your Net Worth Needs to Become the Primary Personal Finance Number You Care About
First of all, what exactly is “net worth”? Net worth simply means the total value of everything you own – your home, your car, any valuables that could easily be resold, and the balances of your checking account, savings accounts, and any investments you have – minus the total of any and all debts you have – mortgage, credit cards, student loans, and so forth. So, if you owned a house worth $100,000 and a car that you could sell for $10,000 but you had $50,000 in student loans (and no other debts), my net worth would be $60,000.
More than anything else, your financial focus should be on this number and how you can make it bigger. There are a lot of ways to make it bigger: paying off debts, not spending money on foolish or wasteful things, improving your income, and, yes, investing.
The best way to sum up the transition is that focusing on your checking account is a very short-term perspective, while focusing on your net worth is decidedly a long-term perspective.
If you don’t have a long term perspective about things, you shouldn’t be investing, and if you find your checking account balance to be more important and compelling than your net worth, you don’t have a long-term perspective yet.
2. You Need to Pay Off All of Your Credit Cards and Other High-Interest Debts
If you have high-interest debts – anything above, say, an 8% interest rate – there is absolutely nothing better you can be doing with your money than to pay down that debt. There is no investment that offers anything approaching a stable long-term return that beats what you’ll save from paying off your credit cards.
Think of it this way: Making an extra payment on a credit card with a 15% interest rate is functionally the same as making an investment that returns 15% per year after taxes. If you pay off $100 of that balance, that’s $15 in interest charges that you don’t have to pay each year until the card is paid off. There is no investment out there that can even come close to that with any consistency.
Not only that, paying off your credit card will have an immediate positive impact on your net worth and it will cause your net worth to start climbing steadily because it’s not being held back by interest payments and finance charges.
Not only that, getting rid of your debts means fewer monthly bills, which means that you’ll immediately have more money to invest with than ever before.
It’s simple: If you have high-interest debts, you should be paying those off as your highest priority, far above any sort of thoughts about investing. Not only will they offer you a better return than any investment, paying them off will rapidly improve your net worth and it will improve your monthly cash flow. This is your first step. Take charge of it.
3. You Need to Eliminate Most of Your Worst Personal Spending Habits
When it comes down to it, there are really two ways to effectively increase your “gap.” You can either spend less money or earn more money. We could write endlessly about methods of earning more money – getting a better job, getting a raise, starting a business – but we are actually going to focus on the spending part of the equation because that’s something you can take direct action on right now and see results almost immediately.
The thing is, most people get an immediate bad taste in their mouth when they consider cutting their spending. And they shouldn’t. The reason people get that negative reaction is that they initially think of the spending that they care the most about and they don’t want to cut it.
They think about the money spent on slightly extravagant meals with good friends. They think of the last hobby item they bought that they really enjoyed. The idea of cutting those things seems terrible.
And it is terrible. Those aren’t the things you should be cutting.
What you should be cutting are the forgettable things, the purchases you won’t remember in a day, the things that are just quietly purchased and quickly forgotten. A drink at the convenience store. An extra item tossed in the cart at the grocery store.
The digital item bought on a whim, enjoyed once, and then forgot about. The latte consumed without thought or real pleasure in the morning. Those are the things you should be cutting, the things you won’t remember a day after you spend them.
Watch for those things. Be on guard for them. When you see yourself about to thoughtlessly spend money on something that doesn’t really matter, stop yourself. Don’t spend that money. Cut that purchase from your life. Focus on eliminating whatever routine that brought you to the point of making that thoughtless purchase.
Do that throughout your life and you’ll find yourself spending a lot less money on unimportant things, which frees up a lot more money for investing.
4. You Need to Establish a Cash Emergency Fund
Like it or not, life sometimes intervenes in the best laid plans. You might have a great investment plan, but what happens if you lose your job? What if you get sick? What if your car breaks down?
In those situations, many people turn to credit cards, but credit cards aren’t the best solution. They don’t help you with identity theft problems at all. If you’re struggling financially, banks can sometimes cancel the cards. Not only that, even if everything goes well, you still have a new debt to contend with which can still upset your plans.
That’s why we encourage anyone who is investing to have a healthy cash emergency fund stowed away in a savings account somewhere. It’s there solely to ensure that life’s emergencies don’t upset your bigger financial plans.
Set up an online savings account somewhere with an online bank of your choice and then set up an automatic weekly transfer from your primary checking into that account for some small amount that won’t kill your budget but will build up reasonably rapidly.
Then forget about it. Let the cash build over time. Then, whenever you need some money for an emergency – a job loss or something else – transfer money back into your checking. We recommend never turning off the transfer; if you find that the balance gets too high for your tastes, take some money out of the account and invest it.
5. You Need to Figure Out What Your Big Life Goals Are
One of the key principles of investing is to never invest without a purpose. There are many reasons for that, but the big one is that without a specific purpose in mind, you can’t really assess your timeframe for investing and how much risk you’re willing to take on, both of which are vital questions when it comes to investing.
Take the stock market, for example. It’s very volatile, meaning that there is significant short-term risk in an investment in the stock market. However, over the long haul – decades, in other words – the stock market tends to gravitate toward a fairly stable 7% average annual return. You just have to be in for the long term for stability.
Thus, if you have a short-term goal, investing in the stock market makes little sense. However, if you’re investing for the long term, it can be a great avenue for you.
All of this thinking should start with your own personal goals. Why are you investing? What are you hoping to do with this money? Are you hoping to become financially independent and live off the returns?
That’s a long-term goal, so stock investing might make sense. On the other hand, maybe you’re investing to buy or build a house in a few years. In that case, investing in stocks probably isn’t the best idea, since you’ll need the money reasonably soon.
What’s your goal? Why are you doing this? Figure that out before you invest a dime.
6. You Need Your Spouse to Be on Board with Your Plans
If you’re married, any investment plan you take on should be discussed in full with your spouse. That discussion needs to cover at least three key points. First, what is the goal? Why exactly is this investment plan going to happen? What are we hoping to achieve?
Second, what is the plan? How exactly are we investing to achieve this goal? Do the investment choices make sense? Where are the accounts and whose name is on them?
Finally, is this something we both agree on? Is the goal something that we both value? Is the plan something that matches our values while also achieving the goal?
If you don’t have this conversation with your spouse before you start investing, you’re begging for trouble down the road, trouble that can start as soon as your spouse notices the money vanishing into an investment account.
7. You Need a Healthy Understanding of Your Investment Options
Another important step before you invest is knowing what different investment options are available to you and how to interpret them.
Do you know the basics of what stocks and bonds and mutual funds and ETFs and index funds and precious metals and real estate are? Do you know how to compare two similar investments to each other? You need those skills before you begin to invest.
If this is something you’re unsure about, I highly recommend picking up an investing book and giving it a full readthrough before making any investment moves at all. My personal recommendation for a really good all-in-one investment book is The Bogleheads’ Guide to Investing by Larimore, Lindauer, and LeBoeuf.
It is a spectacular one-volume book on investing in how it connects real-life concerns and goals to investment options and explains how different options work and meet those various concerns and goals.
Even if you plan to have an investment advisor handle your investing, you should still take the time to understand the things that your money is going to be invested in. Simply trusting someone else to handle it is usually a bad move.
8. You Need to Have a Bank That Handles Online Banking and Automatic Transfers with Ease
This should be a given for most people today, but it needs to be mentioned. Before you start investing, your bank should be equipped to make it easy to do online banking and to set up automatic transfers both to and from the bank quite easily. If your bank doesn’t offer these services, look at another bank.
The reality is that most banks today offer these things. Robust online banking is nearly a standard today, as are automatic transfers to and from checking accounts. Banks that don’t offer these features are intentionally making themselves obsolete.
Why are these features so important? For starters, you’re going to need to make automatic transfers if you want to set up a regular investing plan of any kind. Automation is a big key to investing success – you want your plan to basically run on autopilot.
You’re also going to want to be able to check regularly and make sure that money is being transferred out of your accounts, which you’ll need online banking for in order to make it convenient.
If your bank makes any of this difficult, start shopping around for another bank.
9. You Need a Social Circle That’s More Supportive of Smart Financial Moves Than Excessive Spending
While it’s absolutely vital that you switch to a mindset that’s focused on net worth and positive toward smart financial moves, you should also keep in mind that you are strongly influenced by your immediate social circle as well. If they’re not committed to those things, it’s going to be substantially harder for you to make those kinds of commitments.
Look at your social circle. Who are the people you see most often, particularly outside of work when you have the freedom to make those choices? Are those people financially minded? Do they make smart spending choices? Or are they constantly buying new things and talking about their latest purchases?
If you find yourself in a social circle that doesn’t ever consider smart personal finance and is constantly talking about the latest things and bragging about their latest expenditures, you should strongly consider shifting your social circle.
Spend some of your free time at the gatherings of people with a stronger financial perspective. Look for an investing club on Meetup, or simply explore other friendships with people you might not have ever hung out with before. You’ll build some new relationships over time, ones that are supportive of positive financial progress.
10. You Need a Healthy Relationship with Your Wants and Desires
This is the final strategy for getting ready for investing and it’s a big one. You need to have a strong grip over your wants and desires. You need to rule them; they shouldn’t be ruling you.
It’s inevitable to want things sometimes. That’s human nature. We see tasty foods, delicious wines, items related to our hobbies and interests, and we want them.
The question is, what do we do then? Do we go ahead and buy that item as soon as reasonably possible? Do we put up the facade of thinking about it for a while before buying? Or are we patient with that desire, giving the impulse plenty of time to fade away before deciding that this is worth paying attention to?
Impulse control is one of the most powerful tools that an investor can have in their toolbox, and one of the most obvious ways that you can see whether you have it or not is when you’re considering purchases that you desire.
Do you have the self-control needed to avoid giving in to every momentary want and desire? If so, you’ll not only find it easy to have the resources you need to invest, you’ll also find it easier to have the self-control needed to tolerate the ups and downs of the market.
Top 10 Ways to Start Investing Without Knowing Anything
Nowadays anyone can start investing with a very small amount of money. Due to the proliferation of retail investment products available, you can invest as little as $100 into a basket of stocks and bonds. For a rookie investor I would generally recommend staying away from individual stocks.
1. First, look at your debt, cash flow and liquidity needs.
Before you invest, erase your high interest debt. It doesn’t make sense to carry a 24% interest rate on debt and using your extra money to invest. You can’t get that guaranteed 24% return on any investment. However, paying down a credit card with that interest rate is the equivalent of earning that return.
Also, make sure you have an emergency fund. One should have the equivalent of 6 – 9 months of living expenses parked safely somewhere, such as in CDs.
“Liquidity” means having cash on hand when you need it. For example don’t put money into the stock market that you will need in 2 to 3 years for a major purchase.
2. Determine Your Investing Timeline
This goes hand-in-hand with liquidity needs. What are you investing for? Is it truly extra money you don’t need for a while? Are you investing for your retirement 20 or 30 years away? For your children’s college education? Is this a short-term investment? Something you may need in 2 to 3 years?
The general rule is for shorter timelines go with less volatile, “safer” investments such as bonds or other fixed income instruments. For longer timelines—longer than five years—it’s okay to invest in stocks.
3. Develop a Plan
A written plan, called an Investment Policy Statement (IPS), helps you get organized, puts down your goals and determines the criteria of your investments. These may be paying for a child’s college education, funding your retirement or just growing your wealth.
This information will dictate the amount of return you need on your investment and how soon you’ll need it. This in turn will determine the amount of risk you may need to take in order to achieve a reasonable return. Also, how and where are you going to invest it?
There are many low-cost online brokerages such as Schwab, Fidelity and Scottrade where you can open an account with a small amount of money by transferring funds from your bank account very easily.
4. Research, research, research.
Read all you can on retail investment products such as Mutual Funds, ETF’s, ETNs, etc. and educate yourself on their differences. Visit online resources such as morningstar.com, investopedia.com, fidelity.com, fool.com and vanguard.com to get familiar with investing basics, various types of risks, and investment vehicles.
5. Find Your Comfort Zone
Since all investments come with varying degrees of risk you need to assess your risk–tolerance. Being in your investing “comfort zone” means owning a portfolio that contains suitable, well-researched holdings that are in perfect alignment with your various goals, time horizon, and risk tolerance.
Determining one’s risk tolerance is a very deep and complicated subject and a wealth of information is available online about it.
6. Determine Your Mix: Asset Allocation
Your asset allocation is the way your portfolio is divided between bonds, stocks, and cash and should be based on your specific goals, risk tolerance, and time horizon.
For example, there is a general rule when constructing a portfolio that one should have their age in bonds in a typical stock and bond mix. So, if you’re 40, you would have 40% of your portfolio in bonds. This rule basically says the younger you are the more risks you can take on with your investments i.e. tilt your portfolio more towards stocks. They are generally more volatile, but have higher long-term returns versus bonds.
7. Diversify
In order to reduce the risk you need to mix a variety of investments in a portfolio. The rationale behind this is that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment. The benefits of diversification will work only if your holdings in the portfolio are not perfectly correlated.
8. Control Expenses
Investing comes with certain expenses, buying a Mutual Fund for example. They usually charge an annual expense around 1% of assets. This means they will take out this expense regardless of how the fund performs every year. If you’re buying ETF’s there may be brokerage transaction costs and management fees. It has been shown that controlling expenses is a big determinant of future long-term returns.
9. Minimize Taxes
One usually has many types of accounts, retirement and taxable accounts. In what type of account to carry what kinds of investments becomes important. Choosing the right one can help you cut taxes and keep more of your investment gains.
For example, those whose gains are taxed as ordinary income would belong in tax-deferred accounts (such as REITs and bonds). More tax-efficient investments (such as stock ETFs and tax-free municipal bonds) would belong in taxable accounts.
10. Rebalance
Rebalancing your portfolio on a regular basis is the process of realigning the mix of your portfolio. Rebalancing—at least once a year—involves periodically buying or selling investments in your portfolio to maintain your original desired level of asset allocation.
Keep in mind: all investing involves risk, including the risk of loss. Diversification does not ensure profit or guarantee against loss. Good luck and happy investing!
What are Some Tips for Beginner Investors
Are You Investing For Retirement?
First, you have to decide what you’re investing for. If it’s for retirement, consider your 401(k) and IRA options. If you’re young and are in a low tax bracket, the Roth IRA is a great option.
Whether you’re looking for a retirement account, or a taxable investing account for the short-term or medium-term, consider a low-cost company like Vanguard or Fidelity. Getting set up with them is very easy. Simply create an account on their website, and they’ll guide you through the process to get you set up. If you’re not sure which kind of account you need, there’s a clear hierarchy of investment accounts that you should follow.
It may feel overwhelming at the beginning. You have so many investing options and may not know where to start. You can invest in stocks, bonds, ETFs, and the list goes on. Thankfully, we’re here to help.
If you’re young, you likely want to invest heavily in stocks, which tend to perform best over long period of time. If you’re in your 20s and 30s and you are going to have this money for 40+ years, stocks make a lot of sense.
Don’t Invest It All In One Stock!
Now that we know to invest in stocks, that still leaves almost an unlimited number of options. Should you put all your money into one stock? Apple has performed well, right? So should we just buy that and let it ride? Absolutely not! Diversification is really important. One stock might be volatile, but if you own bits of a lot of stocks across industries, you’ll be better protected from large swings.
Let Mutual Funds Do The Work For You
To diversify properly, we want to buy different stocks that cover different industries. And the best way to do that is to invest in a mutual fund. A mutual fund is a collection of stocks, so instead of you buying a little bit of each stock (which can add fees for each trade), you can effectively own parts of many stocks, without having to pay a $5-$10 fee for each trade.
Read Also: How Investing can help you generate more Income
You don’t need to be an expert to begin investing. Unless you want to do a lot of research, why not let someone else do the work for you? This is what makes mutual funds so attractive. Mutual funds are often run by groups of experts, so they do all the work, and you get to take advantage for a relatively low rate of 0.5%-1.5% of fees, or $5-$15 of each $1,000 invested.
Index Funds Are Incredibly Cheap
To take it a step further, index funds are a type of mutual fund that tracks a specific index, like the S&P 500, for example. The reason we are such a fan of index funds is that since nobody is doing any manual stock picking (the stocks in an index are fixed, so a computer can do the work for us), the fees can be really low.
For example, Vanguard has an S&P 500 index fund with fees of just 0.05% of your investment. Practically, this means that for every $1,000 you have invested, you pay just 50 cents!
The thought of starting to invest can be daunting, but getting started doesn’t have to be hard!
Conclusion
Like you have seen from this article so far, investing does not really have to be very difficult if you follow the tips and the it the right way. Even if you do not have the needed experience, you can invest and start your journey to wealth with these tips.
