This post is about investing, but I first want to recognize that even having the cash flow to invest is a big hurdle for many. Over the past couple decades wages have grown at a slower pace than the cost of living. It’s also become the norm to graduate with student loan debt, which creates added pressure on finances of millions of Americans.
Once you have the cash flow to invest, there are some key concepts that you will want to keep in mind as an investor.
Both new investors and those who have been investing for decades make mistakes. With that being said, it’s more likely for a new investor to make a mistake than one who has been investing for multiple decades. These investors have likely been through a recession and seen the value of their stocks drop rapidly, and have (hopefully) learned to invest for the long-term instead of being reactive to market swings.
Let’s dive into some of the key concepts, which I’ve put in terms of “Do” and “Don’t.”
Do: Take Full Advantage of a Company Match
Some companies will match employees’ contributions to a retirement account (for example a 401k or 403b) up to a certain percentage. For example at my employer we receive a 100% match up to 3.5% and a 50% match from 3.5 to 6%. Meaning, if I contribute 3.5% of my paycheck towards my 401k, my employer will match that dollar-for-dollar. And between 3.5% up to 6% they will contribute $0.50 for each dollar I contribute.
There are few – if any – situations in personal finance quite like this. Your employer is literally giving you an immediate 50%-100% “return” on each dollar you contribute towards retirement. This is huge! Taking advantage of this perk is really important, even if you have debt that you want to pay off.
Do: Pay Off Debt Before Investing When it Makes Sense
The advice “get started investing as soon as possible” has been overdone and you most likely have heard this many times, so I will only touch on it briefly. What I’ve found is that the thing most people struggle with is whether to invest or pay off debt. They know that investing earlier is better, but they also know that paying off debt as fast as possible is also important. So when should someone invest instead of pay off debt?
As I mention in my book Student Loan Solution, most experts quote 5% interest rate as the tipping point of when you should invest instead of pay off debt. Psychology is also involved, though, and some people with debt below 5% will still prioritize eliminating it because they know they will sleep better at night once they are entirely debt free. There are also those who are on the path to student loan forgiveness who would benefit from minimizing their student loan payments as much as possible. In general, though, the 5% rule is a good one to keep in mind. That means high interest debt, such as credit card debt, should be prioritized before investing.
The exception is the company match I just mentioned. Unless your debt is over 50% interest rate (such as a payday loan), in general, an employee should take full advantage of the company match before paying off debt.
Do: Build an Emergency Fund Before Investing
So we’ve established some guidelines of when to invest or pay down debt. But there is one other thing to take into consideration before you dive into investing: an emergency fund.
Building an emergency fund had a big impact on my life. Knowing that I had three months of cash set aside in a savings account gave me a buffer in case of a job loss or a large unexpected expense. Investing is important, but having cash set aside for an emergency is also important.
It’s not easy to build an emergency fund, but I think it’s one of the best things you can do for your finances (and stress). If you don’t have an emergency fund it can be difficult to imagine how you would set aside 3+ months of expenses. My advice is to focus on just getting started and making progress, not on the final number you want set aside. Here’s a post about how you can build an emergency fund $100 at a time.
Don’t: Try to Time the Market
Attempting to time the market has lost millions of investors huge sums of money. If you pay attention to the news you likely know that there is always someone saying that the market is going to take a dive, while at the same time others are saying the market will continue to increase for the foreseeable future.
This is all about money mindset. As an investor it’s extremely important to think of the long-term and not the short-term. The best way to avoid getting hung up on the movement of the market is to invest regularly. That way you will invest when the market is relatively high or low. Sure you may end up investing right before the market drops, but you will also invest when the market is at the bottom. Regularly and consistently investing is the best way to avoid trying to time the market.
Don’t: “Stock Pick” – Focus on Index Funds Instead
Let me take a moment to recognize one of my investing mistakes. I invested in a publicly traded social media marketing company. I did all my homework: I listened to their quarterly earnings calls, consumed whatever information I could about their company and industry, followed their leaders on Twitter, got their press releases, and ran calculations in an Excel spreadsheet using their financials.
I invested about $5,000, and when I finally sold I had lost about $2,000.
Instead of putting that $5,000 in an individual company stock, I could have invested in a broad-based index fund and let it move with the broader market. If you aren’t familiar with index funds, they are mutual funds or Exchange-Traded Funds (ETFs) set up to track the performance of a benchmark index, such as the S&P 500. Said differently, they move up or down in price based on a large basket of stocks. Read my post Index Funds Explained for an overview.
While I’m not licensed to recommend specific investments, index funds are almost certainly the right approach for new investors. First of all, it’s very difficult for experts who analyze companies full-time to accurately pick stocks that will outperform the market. The odds are slim of a casual investor picking stocks that will outperform the market long-term. Second, most new investors won’t have enough funds to appropriately spread their risk across a variety of companies. If you only have $10,000 in the market, you’d end up having a small amount in many stocks if you wanted a diversified portfolio. And finally index funds help investors avoid selling low and buying high. If you believe the market will increase 8-10% on average long-term, you are more likely to stick with an index fund even when it’s lost value.
Do: Avoid High Fees
Let’s say you started to invest in your company’s 401k and 403b. Making the decision and following through with getting money into your retirement account is a huge step.
I want to take it one step further and point out the high fees that come with some of the mutual fund options within employer retirement accounts. The less fees you can pay the better, because fees go directly to the company managing the mutual fund.
This is important regardless of whether you have a 401k or 403b, but it’s especially important for those who have a 403b. A 403b is the equivalent of a 401k, but for nonprofits. They typically come with worse investment options. My wife has a 403b and I could hardly believe that there wasn’t even one low fee passively managed index fund.
Check out my free 401k spreadsheet (can be used for a 403b as well) to analyze the fees in your retirement account. Again I can’t make individual recommendations, but what I would recommend doing is plugging your options into the spreadsheet and filtering based on fees. Get rid of all the high fee options and look at the low fee options.
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Investing can be complicated, but if you focus on these key concepts and simplify your approach to investing you can get started off on the right foot – or correct course if you’ve already made some mistakes.
If you are interested in going deeper into this topic, my friend and fellow blogger Erin Lowry published a book called Broke Millennial Takes On Investing: A Beginner’s Guide to Leveling Up Your Money, which I highly recommend.
I already acknowledged earlier that simply getting started is a big hurdle to clear, but many people I talk to want to speed up their path to financial independence, regardless of their situation.
What I love about personal finance is that it ultimately is about strategy. If you want to speed up paying down your debt or building up your investments, increasing cash flow is what you’ll want to focus on. Here’s a post about increasing cash flow to invest more money and if you are looking for more motivation, here’s how a side hustle can drastically improve your retirement savings (with examples).
from Young Adult Money https://ift.tt/2Wc41UL
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