Ask anyone if investing is a good thing, they will say yes. Everyone knows they SHOULD invest but it still seems like a daunting task. It seems overly complex and you just don’t have the time for that now. We say we will get to it someday in the future.
And it’s true. There are many aspects of investing that are complex and take years of experience to understand. We won’t worry about that stuff.
What ODs need to worry about is learning the basics of investing and forming a coherent investment strategy. This plan will get you ahead of most investors out there and set you up to meet your goals.
And while we all know that investing is a good thing, how do we go about doing it? It’s a loaded question. Kind of like when a friend asks you which contact lens is best for them, but you know nothing about their prescription or lifestyle. Until you get more information, you can’t give a solid answer.
Investing is the same way. There is no “best” investment out there. You really have to do the work to find what’s best for you and your family.
Investing is a process and investment strategies are not made overnight. Here’s how I would get that process started:
Step 1: Set goals that are important to you
Setting goals is the most important step in the investment process. Digging deep and finding what goals are the most valuable to you will guide where you should put your money and what you should be investing in. Doing anything else is blindly throwing money into arbitrary investments.
And goal setting is the step most people skip. Mainly because it requires the critical thinking and doesn’t produce any returns right away. But setting appropriate goals will set the foundation for your investing future.
But what type of goals should you set? The two goals that everyone should set from the get go are creating an emergency fund and saving for retirement.
The purpose of creating an emergency fund is two-fold. It will allow you to cover any major expenses that come up. Things like a broken dishwasher, a failed transmission and a new roof (which all tend to happen at the same time) are some inevitable things in life. An emergency fund will allow you to pay for these things right away without stretching your budget or going into debt.
The second useful purpose of an emergency fund is it can allow for more freedom in other areas of your personal finances. You can set your insurance deductibles a little higher since you can cover any events with cash. You can take advantage of irresistible investment opportunities since you have the capital to cover it. And maybe you can finally start that practice since you can cover your personal expenses with your emergency fund.
With saving retirement, it is essential to start early. While retirement seems far off and like something out of a dream, the fact is that we will all retire from work some day, and some of us may have to before we want to. You might have to take care of family or a personal health issue will prevent you from working. Or maybe you just get burnt out. It happens.
Starting to save for retirement early on in your career will allow you to build up the funds you need to live when you are not working for a living anymore. The compounding growth that time brings will hopefully afford you a more comfortable retirement than most.
Besides these two goals of a healthy emergency fund and retirement, the rest is up to you. You can save up for a house or an around the world vacation. If you have kids and want to save for their education, that’s an honorable goal too.
Or you can save money to start up that practice or side business you’ve always wanted. Divide these goals into short term, medium term and long term. This will determine what your investment strategy will look like.
This is the part where you think about the life you want and shape it. Investing will help you get there.
Step 2: Learn the basics of investing
There are tons of places to learn about the nuances of investment. But being knowledgeable about a few core areas will get you where you need to go. Here are some basic investment concepts everyone should know:
Risk/return: In general the more risky an investment is, the more return you should expect. But with high risk comes the higher potential of loss.
The stock market is a great example of high risk high reward. In the long term the stock market as a whole tends to go up. The S&P 500 index, for example, has increased by 1,027% in its 90 year existence. This comes out to 11.4% of growth per year, which is a pretty good return. But those 90 years saw huge drops like the Great Depression which occurred in the 1930s and the more recent Great Recession in 2008.
But despite those big drops, someone who invested in the index since the beginning would see some nice returns today. So if you take on investments with high risk, expect good long term returns while riding on a roller coaster!
Diversification: Being well diversified is an important part of an investment strategy. It can allow an investor to achieve high returns with high risk assets, but lessen that risk by choosing assets that are not correlated to each other.
So while a US stock fund and an international stock fund are both considered high risk, they are not similarly correlated so you won’t take gigantic losses all at one time. It’s a nice way to increase potential returns while minimizing huge losses.
Asset allocation: This is another important investment strategy that seeks to balance risk versus reward by adjusting the percentage of your assets based on your risk tolerance and time horizon of your goals.
This is where categorizing your goals by time frame will pay off. You can use high risk assets for your longer term goals and lower risk assets for your shorter term goals. Combining the strategies of asset allocation with diversification will form the basis of choosing your investment appropriately while minimizing the volatility of your returns.
And always try to be on the lookout for new investment knowledge. Read books and follow reputable blogs. Tax and investment laws are always changing, so it really pays to be on top of the investment world.
Step 3: Where to put your money
Once you figure out your goals and decide how to allocate your assets, you need to put them in the appropriate type of account. Here are some of the more common account types:
Online savings account: These are easy no frills accounts that have a set interest rate. They are FDIC insured, meaning if the bank goes out of business for some reason, the government will get your money back to you. So they essentially carry no risk.
These are ideal for short term savings like an emergency fund or an upcoming house down payment.
401k: These are employer sponsored accounts that allow you to contribute and invest money on a pre-tax basis. Meaning, your contributions are not taxed in the year you make them. They will be taxable upon withdrawal. There is a self employed version called a solo 401k with similar contribution rules.
These accounts are ideal for long term retirement savings, especially since you will be hit with a 10% penalty if you withdraw money before a certain age.
Traditional IRA: Similar to the 401k, these are pre-tax retirement accounts. You can open these on your own at almost any big brokerage firm, like Fidelity or Vanguard. Though there are some restrictions on if your contributions are tax deductible, you can generally make fully tax deductible contributions if you don’t have a workplace option.
These accounts are ideal for long term retirement savings since they also have a penalty for early withdrawal.
Roth IRA: These accounts use contributions that are already taxed. Which means you get no tax deduction for contributions up front, but you can withdraw money tax free in retirement. Though there is a penalty for withdrawing any investment gains before a certain age, you can generally withdraw any contributions you’ve made at any time as long as you have had the account for 5 years.
These accounts have some income restrictions so if you make above a certain amount, you won’t be able to use it — which isn’t the worst problem in the world. These accounts are ideal for retirement savings.
Traditional brokerage account: These are accounts anybody can open at any time with any of the big brokers. They offer no tax deduction, but money can be contributed and withdrawn at any time. Investment gains are subject to capital gains taxes, which are usually lower than regular income tax rates if you hold the investments for at least a year.
Since these accounts are very flexible and liquid, they are ideal for any type of goal. You just have to allocate your assets for the goal you want. They’re a great choice if you’ve exhausted all of your tax advantaged account options.
Step 4: Invest early and often
Now that you have your assets in the right place and figured out where you want to put your money, it’s time to add some money to the buckets! As long as you have a reasonable asset allocation plan, your savings rate is what will determine your investment success for the most part.
The best time to save is now! Saving early will allow more time to help compound your returns exponentially. This will be the biggest determinant of your investing success. Many salespeople will try to tell you that paying them to pick the right investments is the way to riches. Don’t fall for the trap!
How much of your income you choose to invest early on will be the biggest factor in your investment engine. Keep the engine running by making steady contributions. You’ll be surprised at how much money you can accumulate this way.
Step 5: Forget everything and put it all on Bitcoin
Just kidding! Putting all of your money into one asset is a terrible idea in general. Putting it all into an alternative investment like cryptocurrency is just plain foolish.
Bitcoin and other cryptocurrencies are a very speculative and very volatile investment. There is not much data on them and they really have no business as a major asset in your investment plan. If you must be in the game, put a very small percentage of your investment capital. Maybe 5% or less. The majority of your investments should be in things that have an underlying value, such as stocks or real estate.
As an example, recently a service named BitConnect went out of business, but not before taking lots of money from people by promising guaranteed returns and a return of capital. Any investment that touts itself as “guaranteed” or “can’t lose” is probably a scam.
Keep the majority of your investments in stocks, bonds or real estate. Alternative investments like cryptocurrencies should be 5% or less of your investment portfolio.
Being a successful investor takes some thought and planning, but anybody can do it. It is not as difficult as some make it seem. If you can graduate optometry school, you definitely have the mental capacity to be a successful investor.
Being thoughtful about your goals, where you want to invest and choosing the right accounts is crucial. But the most crucial part is keeping your savings rate high and contributing consistently.
Follow these steps to start your investing journey. You’ll find it to be a much more enjoyable trip than you think.
For more OD-specific tips on finance from Syed, check out The Broke Professional!