Start Your Investment Journey With These 5 Basic Principles
Are you new to investing? Or you may want to hear another perspective on investing. Here are the five basic principles to start your investment journey.
A recent National Institute on Retirement Security report found that the typical Generation X household only has $40,000 saved for retirement. According to an Urban Institute report, Millennials are projected to have higher incomes but experience a lower standard of living.
One of the key reasons for this is that Generation X and younger generations were not taught the basics of financial education. One aspect of financial education is investing. I had to learn this information by reading financial education articles, listening to podcasts, and watching videos online. You can start your investment journey with these five basic principles.
You can start to invest in your financial future the early you apply them. You may want to invest to retire. You may want to invest to use the money to reinvest into a venture. You may be aiming to have one million dollars invested in the stock market as a goal. No matter what your objective is. It is always a good idea to start sooner. The sooner you start. The more you can allow your money to compound and grow.
You can make your money work for you instead of you always having to work for your money.
Principle #1: Pay Off Any Debts First And Build An Emergency Fund
Before investing in the stock market or your own business venture, you want to be debt free. You want to have all of your debts paid off. A great financial habit to develop is to live below your means.
Living below your means can also help you get out of debt faster. You live beyond your means when you spend more monthly money than you make. Living above your means will only continue your cycle of remaining in debt. In contrast, living below your means means you have extra money left over at the end of each month you can save. You can direct the additional money to pay off any debts you may have.
You want to pay off any debt because your income is vital to building wealth. You cannot start to build wealth if you have to make a monthly payment to pay off any debts you may have: student loans, car loans, credit cards, et cetera.
You then want to work to build an emergency fund. An emergency fund prevents you from using any of your investments that you are planning to have for retirement or another long-term purpose. The amount you should have in your emergency fund varies. You want your emergency fund to cover at least six months’ expenses. If you can increase it to cover a year’s worth of costs, that is even better.
You can use this emergency money calculator by Money Under 30 to estimate how much you should have in your emergency fund. The purpose of an emergency fund is to help you get through a difficult time or a large unplanned purchase. You could opt for the more conservative estimate using the emergency money calculator to assess how large of an emergency fund you should have.
You never know when an emergency will happen or how long you cannot find work. A major health issue could even arise that could prevent you from working for a long time. An emergency fund is a financial strategy to help you when an emergency happens.
Debt makes you have a negative net worth. You want to start to pay it off so that you can begin to have a positive net worth.
Related - The Seven Steps To Get Out Of Debt
Principle #2: Find Ways To Increase Your Income
You can always be on the lookout to find ways to increase your income. The more income you bring each month or year means you have more money to invest. You can then invest your money into retirement accounts.
You could start by trying some different side hustles. These would be ways to make some extra money on the side of your full-time job. Depending on the side hustle, you could replace your current full-time job. You could even turn the right side hustle into a business. You can even turn an online side hustle into an online business.
The reason to raise your income is that you can invest more money. The extra income will allow you to increase the money you can invest each month. It can then compound over time depending on how your investments do.
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Principle #3: Invest In Tax-Advantaged Retirement Accounts
You can start to invest in tax-advantaged accounts from your current job or if you are self-employed.
You want to budget to invest at a minimum of ten percent for retirement each month. It will depend on what budget strategy you are following. If you follow the 60/30/10 budget, you can invest at least ten percent each month for investments. Of course, you can always increase it to invest during some months. As your income increases, the amount you can invest will also rise.
There are three main ways to determine where you want to invest your money, first with the pre-tax and after-tax accounts.
Your employer can match your contributions to your Thrift Savings Plan (TSP), 401(k), or 403(b) as an employee.
You can invest in a Roth account as an individual or an employee. You can take advantage of your employer’s Roth 401(k) at work. You could invest ten percent into your employer’s Roth 401(k). Your employer may match what you contribute to your Roth 401(k). This is a great way for employees to increase their money in a retirement savings account.
If you are self-employed or your employer does not offer a Roth 401(k), you can max out your Roth IRA.
Here is a useful Nerdwallet Roth IRA calculator to help determine how much your Roth IRA contributions could be worth once you retire.
If you have yet to reach your maximum investment amount for your Roth IRA for the year, you can then invest in your Thrift Savings Plan (TSP), 403(b), and 401(k). You could also max out these plans if you have extra money to invest.
After you max out your Roth IRA and other retirement accounts, you can start to invest in the stock market.
Principle #4: Invest In ETFs, Index Funds, And Dividend-Paying Stocks
If you manage your portfolio, you can invest in exchange-traded funds (ETFs), index funds, and dividend-paying stocks. This is a simple strategy. You can always make a strategy more complex as you get more sophisticated.
Exchange Traded Funds (ETFs)
You do have to pay a fee for using ETFs. The fee will be less than if you had an active fund manager. Your fund manager or group of managers would get a cut from your actively managed funds. US News and World Report write regarding financial advisors:
“On it, Stephen J. Dubner reaches a well-reasoned conclusion – backed by financial industry immortals – that the money spent on fees is a waste compared to the strategy of the passive fund that tracks a market index. He cites a study where only the top 2% to 3% of active fund managers had enough skill to cover their cost.”
ETFs have become a popular alternative to actively managed funds. Below are eight reasons why ETFs are booming:
ETFs cover all of the major assets, styles, and sizes (small cap to large cap to niche assets)
ETFs have low annual expense costs
ETFs are transparent and simple to understand
ETFs can provide a primary position for investment portfolios
ETFs can join long-term market trends
ETFs do not normally have taxable year-end distributions
ETFs are liquid
ETFs have a low minimum investment requirement
ETFs have become popular because they trade like stocks. ETFs are less expensive to buy. ETFs allow you to diversify across market sectors and companies rather than investing in a single company as a shareholder.
Index Funds
You can invest in index funds. An index fund aims to mirror the behavior of the categorized index. An index fund holds representative or all of a type of securities of a particular listed index.
There are three main benefits to investing in index funds:
Index funds make it easy to diversify your portfolio. The S&P 500 index can give you broad exposure to the top companies on the stock exchange. You could also invest in a small-cap index fund.
Index funds are low-cost. They are passively managed like ETFs. This means that the funds within the index you invest in are based on a specific index.
Index funds are great for long-term returns. Index funds can beat actively managed funds. Passively managed funds are an excellent option for investors with a long-term view of the market and investment strategy.
Index funds save you the cost of having a financial advisor who may not help you get better returns in the stock market. Below is what Warren Buffett wrote in his 2014 shareholder letter about index funds.
Dividend Investing
You can invest in individual dividend-paying stocks. These are shares of stocks that pay you a monthly or quarterly dividend for being a shareholder. The stock you are looking at will list how often the company pays dividends. The stock will also list the payout ratio. The payout ratio can be cut or lowered at any time. The payout ratio number will vary for each dividend-paying stock. Dividend stocks are one way to start to build passive income.
Dividend Aristocrats have raised their shareholders' dividends for 25 or more years. Dividend Kings have increased their shareholders’ dividends for more than 50 years. Investing in a company that is a Dividend Aristocrat or King is likely safer compared to owning shares in a company that pays a dividend but lacks the long track record for raising or paying its dividend to shareholders.
Two reasons to have dividend stocks in your investment portfolio are:
Consistency of the company to pay you a dividend is a form of passive income. You can use the DRIP method to reinvest your shares to purchase more of the same stock.
A hedge against inflation because you earn the dividend and if the stock rises in value.
You can use ETFs to gain exposure to a wider market sector. Index funds can help you to mirror the market. Purchasing shares in individual dividend stocks can help you to build passive income. These three strategies are intended for long-term investing.
Principle #5: Consistently Invest And Think Long-Term
Finally, you want to consistently invest monthly into your retirement accounts and the stock market. You also want to think long-term. The combination of these two things will help you with investing.
Modern culture wants you to consume and think short term. Purchasing things you do not need or use could have been money you directed to your emergency fund or invested in the stock market. Short-term thinking prohibits your reasoning and logic skills to only worry about today, this week, or even this month. Long-term thinking allows you to think out one, five, ten, and even your entire lifetime.
You can achieve a dollar cost average by consistently investing in the stock market. It is impossible to time the markets. By consistently investing money into your pre-tax and after-tax accounts, you are increasing the money you will have available in those accounts for when you retire.
Long-term thinking can help you not to worry about day-to-day market volatility. A long-term view can also help you with your investments. Most investments take time to gain a return on the investment. Long-term thinking can also teach you patience and the value of consistency. It takes time to build a diversified stock portfolio. Wealth requires time to build.
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Summary
These are the five basic principles of investing. Consistency and continuing to invest in your retirement accounts and the stock market will help your holding grow over your lifetime. Think long-term in a society that wants you to only live in the here and now.
The best investment is in yourself. You are the one responsible for your financial future.
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