CHAPTER 1
Are You Ready to Become an Investor?
Itâs important to understand the big picture. Investing is the long-term process by which you build wealth, and has two basic componentsâsaving and compounding. Saving is the act of putting money away for the purpose of investing. Compounding is what money does for you by earning interest, by the price appreciation of your investments, or both. Together these two processes grow your money. Once you understand these concepts, you are ready to get started.
Can You Afford to Invest?
You have to start somewhere. At the early stages of the investing process, important questions should be raised. Simply stated, investing without money is like quenching thirst without water. So a great place to start is by asking the question of whether you can afford to invest. Once youâve answered this crucial question, other logical questions will follow.
How Will You Finance Your Investing?
The money you use for investing can come from anywhereâa savings account, an inheritance, or even a lottery win. For most people, investment money is money earned from a job or profession, even a side gig. If youâve got some money already put aside, youâre ahead of the game. The more you have, the better your starting point. One thing to keep in mind: never borrow money to invest until you gain experience and know your way around the markets well. That one act would start your investment plan at a deficit.
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Build your savings first. Billionaires build their fortunes by owning and managing their businesses. The stock market is a place where they preserve the purchasing power of their fortunes. For example, Warren Buffett, through his holding company Berkshire Hathaway, owns businesses such as Geico, multiple local real estate companies in key states such as Texas, and General Reinsurance Corporation. He uses the profits from his businesses to buy stock in other companies such as Coca-Cola and Apple. That way he diversifies his holdings, but also earns dividends and price appreciation from the stock market.
A simple way to figure out if you can afford to invest is to count how much money you have left at the end of the month after all your bills are paid. If itâs $100, thatâs as good a place to start as any, and that is money that will be put to good use by saving it in a bank account or a money market mutual fund. A money market mutual fund is a special type of mutual fund that invests in short-term interest-paying bonds (maturity of less than ninety days) such as US government Treasury bills or what is known as commercial paper (similar short-term bonds issued by corporations). Think of a money market mutual fund as a holding tank for your money while you decide what to do with it. Any amount is good, but the more you have, the better off you will be in both the short and long run. So if itâs less than $100, it means that you need to work a little harder at controlling your expenses or figure out how to make more money, such as exploring a side gig or working overtime. However, be careful that this doesnât interfere with family or other important aspects of your life. Still, even $100 is better than nothing.
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Pay off as much debt as possible before you start investing. Debt is a drag on your ability to save. Think of debt as a big sack of potatoes that you carry on your back everywhere you go. By paying debt down and eliminating it altogether, you are taking a big weight off of your financial shoulders. Being lighter makes you move faster.
No matter what, it makes good sense to have at least $1,000 saved before you make a move such as buying shares in a mutual fund that invests in stocks or bonds, a good entry-level place for investors. If itâs possible, always go for more. So if it was easy to save $100 the first month, get greedy and go for $200 next month, so you can grow your nest egg more quickly and benefit more from compounding.
If you donât have extra money at the end of the month, there is no point in trying to invest yet. In that case, your first step should be to trim your expenses. If youâre trying to make money without some kind of reliable backing, youâre asking for trouble. So donât put your rent or food money into a mutual fund; you may find yourself without a place to live or going hungry.
Details Are Important
Successful investors are very specific about what they are going to do and how they are going to do it. For example, plan what you will set aside for investment, how often you will invest it, and how you will monitor your progress. As time passes and your investments grow, make changes if and when they are needed. Consider revisiting your goals and your expectations. A reliable plan in the early stages of investing is to set aside at least $100 per month until you get to $1,000. While you are saving money to invest, you should also be researching different mutual fund companies to find out which one makes more sense to you. Some of the more popular and reliable mutual fund companies are Fidelity Investments, Vanguard, and T. Rowe Price.
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The major reasons most small investors give up is that they donât have enough cash and that they risk too much too soon. That means that they donât have enough money around to get them through tough times or to recover from mistakes. Markets will always rise and fall, so in order to stay in the game, set aside as much as you can before you try to put it to work. Then keep adding as much as you can as often as possible. Thatâs how you will make the most out of compounding.
Know Your Risk Profile
Knowing how much you are willing to risk in investments is a tricky business, as it depends on both your personality and your ability to be objective based on your circumstances. If you are willing to jump out of an airplane without a parachute, you might like to trade options and futures without doing your research or doing some paper trading without risking real money. Of course thatâs not wise, and I donât recommend it even if you are an ex-CIA agent used to taking outlandish risks. But by the same token, people who donât like to leave their house if there are clouds in the sky donât make good investors either.
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Trading options is risky, but itâs a great way to invest if youâre trying to build income. Consider this technique only after youâve learned about stocks and are experienced in the investing world.
Still, it makes sense to know what your tendencies are. Once you know, you can explore the different kinds of investments and methods that may make sense for you. Regardless of your risk profile, as an investor there is no substitute for planning, study, risk understanding, and patience. Whatâs the best way to figure out your risk profile? Ask yourself these three questions:
⢠How much can I afford to lose?
⢠How much do I need to reach my goals?
⢠How do I react to losing?
If you have only a few hundred dollars to your name, and you need them to get by, you should avoid high-risk investments and concentrate on saving money that you will invest in the future.
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Take your time before deciding and donât be afraid to reconsider a decision. If you are uncomfortable, consider taking other steps to remove your uncertainty. To decrease anxiety, trade on paper where you put imaginary money to work and follow the results without risking real cash. Invest in what you enjoy or are good at understanding. If stocks are not for you, consider real estate, bonds, or even something like investing in a franchise. There are many asset classes and investment opportunities, each one with its own set of risks and potential rewards. A good rule to follow is that if you donât understand it, you shouldnât invest in it.
Think things through. If your goal is to have a million dollars by the time you retire and you are only twenty-three years old, youâre in good shape as time is on your side. In this case, everything depends on how much money you can save over time and how well that money can be invested in order to maximize the combined savings and compounding dynamic. If you get sick to your stomach and pull your hair out when your favorite football team loses a game, lower-risk investments may be the way to go for you, especially when markets become volatile in response to an unexpected event that is well beyond your control.
Setting Realistic Goals and Timetables
Your timetable starts when you decide to start investing. Your first step is to decide when you will open your account and how much you will put in it. If you have money set aside, youâre ahead of the game. If you have less than $1,000, your best bet is to put that money in the bank or in a money market mutual fund and continue adding to the account until you have enough to start investing. Avoid putting that money in a CD (certificate of deposit) or another type of account that wonât allow you to add to it or that will limit how often you can put money in or take it out.
Put It in Writing
Wishing for something wonât help you get it, but writing your goals on paper, reading them frequently, and reviewing and refining them will get you places. The more specific you are, the better off youâll be. Note the goal, the time frame to reach the goal, the amount of money youâll need, how much you have now, and what you are willing to do to get to your goals.
If your long-term goal is to retire early, write down the age of retirement, where youâd like to live, and how much money you think youâll need. Write it in such detail that you can see yourself doing it. âI want to retire when Iâm fifty. I want to move to Cape Cod and live in a house by the shore with a great view of the sea. I plan to do a little consulting work on the side and run along the beach with my dog every day.â Experience this fully every time you look at your sheet of paper or your smartphone. If you have shorter-term goals, like owning a home or visiting a specific foreign country, include those as well and divide your savings and investing capital between them.
Break the process down into stages. Set monthly, quarterly, and yearly goals. Write down exactly how much youâll put into your IRA or 401(k) every month. Decide how much youâll pay in debt every month and to whom and how much money you will dedicate to each area. This process will require a great deal of time and planning, and itâs likely to require adjustments along the way.
Review and Refine Your Plan
Keep a set of lists with clear and concise objectives and revise them frequently, sometimes every day. The time interval between checkups and changes is up to you. The key is to get in the habit of making your financial situation something you monitor and adjust as frequently as it makes sense, especially when your situation and your needs change. Most of all, keep track of how much progress youâre making. Do what makes you comfortable, but check at least on a monthly basis.
Moreover, consider getting help as needed. For example, is your spouse or significant other participating in the plan? Does that person understand the goals? If itâs not going the way you planned, take a step back and review the situation on your own perhaps and then together once youâve given it some thought. Give yourself credit for what youâve accomplished and review where things didnât go as you planned. If your goals change, itâs not a setback, just a reboot. Go through the same process of planning for your next goal.
Simply talking things over with friends or relatives may be helpful. If what youâre doing isnât working, it may be time to get a second opinion. Successful people are usually willing to lend a helping hand to those in need. By raising the issue with someone whoâs been there, you may discover that your problem isnât as big as you think. The answer may be something as simple as getting a recommendation for a good advisor who is willing to be your consultant, or the name of a good investment club.
Find some good online resources for retirement planning and personal finance, like MarketWatch.comâs personal finance and retirement sections. The personal finance section offers great ideas for budgeting, saving money on credit cards, how to get bargain trips, and great general tips on how to save money. The retirement section is terrific for getting organized and staying updated on changes in mutual funds, IRA rules, and what to do with your 401(k) plan.
Discount brokers are great resources for baseline savings and investing information. The key is to continue to build capital. So even if youâre stuck, continue to put money in that savings account or money market mutual fund as you figure out your next move. Just that simple step will keep your future investment fund growing.
How Much Will You Need to Get Started?
Theoretically, you can start with a nickel. But in the real world, the more you have when you start investing, the better off youâll be. Whatâs even more important is gauging how much youâll need to save and invest over time and to adjust this accordingly as your financial situation changes. A rule of thumb used by some mutual fund companies is that you should save eight times your annual ending salary, the money that you have after taxes and expenses, in order to retire. Itâs not likely that a young person can do that right away, so it can be done in a stepwise fashion.
For example, if you start at age twenty-five and you save one time your ending salary by the time youâre thirty-five, the next goal should be to save three times your ending salary by the time youâre forty-five, five times by the time youâre fifty-five, and so on. Remember, this is just a formula. Life isnât always this neat, but you do have a benchmark. You can modify this formula by starting to save earlier, adjusting the amounts more frequently, or changing your retirement age goal. You can also try to put more money away every chance you get as long as you stick to the goal amount. Become a savings machine. If you have a 401(k) plan as your main retirement source, max that out and start a separate IRA to add more money to your retirement.
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Searching through the free content on a mutual fund or bank websi...