Preparation is the key to success with anything in life. Investing is no different.
How many times have we all started to put money away into our investing account, only to have to drain it a few months later when an unexpected bill pops up? Or maybe we saw our funds disappear because we didn’t know what our goals were when we put the money in?
Unfortunately it’s a story all too common. Way too many people fail to lay the proper groundwork before they invest their hard earned money, and because of it see their portfolio crumble and their money ultimately disappear. By preparing a sound investing plan before you begin to invest you’ll ensure success over the long haul, which is what your sights should ultimately be set on. Only after taking time to set your personal investing goals, understand how the markets work, and getting yourself in proper financial order can you recognize that you can, and will be a successful investor.
Start early, start small
Starting your investing journey early allows you to reap rewards later in life…big time! Investing only a few dollars a month can add up to thousands of dollars later in life. The power of compounding interest is huge, and you should begin leveraging it immediately to make sure you have as much money as you’ll need (or more!) later in life.
Lets take a look at exactly how powerful compounding interest can be. Lets say we started investing only $50 a month into an account that earns an average of 5% annual returns over a 30 year time span (very reasonable). 30 years later when it’s time to withdraw our money we’ll find that our small monthly investment turned into nearly 40,000!
Take a look at the chart below to see how your money would have grown if you had invested $100 a month into the stock market for a 20 year period starting in 1993 and earned a rate equal to the S&P 500. You’ll see the power of compounding returns is phenomenal. Start early, start now!
Value of $100 Invested Monthly for 20 Years
Your first venture into the stock market doesn’t have to be a huge one either. In fact, it’s probably wise to start small as you begin to establish your personal investing goals, financial plan, and learn how the market works. It’s all too common a story to hear of beginner investors expecting to put away half of their paycheck into the market. Then when the bills come due, they end up selling their investments and never really get to enjoy the benefit of compounding returns. It becomes a lost opportunity.
You can easily get started by regularly setting aside only a few dollars a week/month into an investing account and purchasing stocks with them as your investing plan calls for. Many online stock brokerages even have an auto transfer feature available to it’s users. All you have to do is enter in how much you want to transfer from your bank account to your investment account, and how often to do it, then they’ll take care of the rest. It’s incredibly convenient, and if you’re investing the appropriate amount according to your financial situation it’s likely you won’t even notice the money missing from your bank account.
As your financial position changes you can always change the amount or frequency of these transfers so you’ll regularly be contributing an amount that’s both significant for growth, yet financially smart so you won’t have to drain your account to pay the bills. No matter how small the amount is, you should make the decision today that you’re going to begin regularly setting aside investing funds.
Establish your personal plan/goal
Establishing your own investing plan is a critical step to investing success. Without a plan, you don’t know how much money you’ll need to retire comfortably. You won’t know how much risk you can take on, how long it’ll take to reach your goal amount, or what to do when something unexpected happens (as it always does). There are few worse feelings than realizing too late in life that you’re not on track to reaching your financial goals. Establishing a sound, and personalized investing plan will ensure you’re on the right path from day one.
Your investing plan should answer at least these 4 key questions:
- What are your financial goals?
- How much do you need to invest regularly to achieve your financial goals?
- How much risk are you willing to take on in your investments?
- How should you manage emergency cash and debt?
Set your financial goals
Establishing your financial goals before any money is invested helps you define the purpose of why you want to invest in the first place. It also gives you a way to measure whether you’re on track to meet them as you progress through life. Your first step should be to calculate how much money you’ll need (both at retirement, and to pay today’s bills). There are plenty of retirement calculators online (one of our favorites), and setting a monthly budget will help you understand how much you need for today’s bills. If you haven’t yet established a budget, you should set one immediately. How can you know how much you can afford to invest at month’s end if you don’t properly keep track of your money?
Determine how much risk you can handle
“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen
After setting your financial goals you’ll then be able to determine your appetite for risk. Generally speaking, the further away the point in time is that you’ll be needing your funds, the more risk you should be willing to take. In turn, the amount of risk you can take will dictate the types of stocks you should invest in.
As a general rule of thumb the well established large cap corporations tend to be less volatile, but also have much slower growth curves. Many of these companies already dominate their industries, and because of it have much less upward potential than their smaller cap counterparts.
Mid and small cap companies on the other hand have much more upward potential. They’re typically much newer companies, and are sometimes in emerging industries which can lend itself to extremely high growth. The flip-side of this is that because they’re newer companies who are still establishing themselves in the market they’re much more volatile.
Smart investors can use this to their advantage. They know that when they’re young, and won’t be needing their investment funds for another 30 years they can afford to take calculated risks on small and mid-cap stocks. If their stock ends up taking a dive they still have years to recover, and if it doubles or triples in price they can really use the power of compounding returns to their advantage!
Keep emergency cash set aside
A good financial plan should also ensure that you have several months worth of living expenses easily available to you before you begin investing. Depending on your financial situation and market conditions you could stick this money into large cap, low volatility stocks, but know that if the market does take a turn for the worse there’s a very real chance you could lose these funds. It’s best to proceed very cautiously when evaluating that scenario. Lots of people simply put these funds into their savings account, and will do it before they put any money into stocks.
Don’t let debt be an excuse for not investing
Finally, consumer debt is one of the biggest factors stopping people from investing. It’s important to understand the balance between paying off debt vs. investing for the future. A good rule is to completely pay off your debt with more than 10% interest before contributing to your investment account. This means completely paying off all credit card bills! With so many consumers in credit card debt this is no minor task, but there’s no use investing in stocks (even if you regularly earn 10% annual returns), if you’re carrying credit card debt with a 14% APR.
For other types of debt with lower interest rates (mortgages, student loans, car loans, etc) it’s generally wiser to make the minimum payments and stick the rest of your money into stocks. In this situation if you were to be able to earn a 10% return from your stocks, and only pay 4% interest on your loans you’re still benefiting by 6%. It’s important to know how your money can best be leveraged in debt situations. Make sure you’re money is working for you, not against!