I follow a number of online discussion boards and a question that I see come up over and over again is, “How do I start investing?”
It’s a complex question not only in terms of your money mindsets, but also dependent upon your personal financial goals and the myriad of options available in terms of investment products and advisors.
If you’re thinking about getting started with investing, use the following 5 steps to break this complex topic down into more manageable chunks.
Step 1 – Start with Why
In his book, Start with Why, Simon Sinek tells numerous stories of companies and entrepreneurs who succeed as a result of starting with the “why” that motivates them. From Apple to Southwest Airlines to the Wright brothers, Sinek relates example after example of how people are much more likely to succeed when they remain focused on why they are pursuing a certain goal rather than simply focusing on the action steps to get there.
So what are your “whys” behind getting started with investing? Do you want to make sure your children have money to go to college? Are you planning to retire early from your current job so that you can pursue an encore career in a completely different field? Do you have dreams of opening your own business? Are you involved with charitable work and want to make a bigger financial impact on your community?
All of us have one or more “whys” behind our saving and investment goals. Keeping yours front and center will help you stay disciplined with your investment plans in the years ahead.
Step 2 – Lay the Foundation
Before opening that first brokerage account, make sure you have cash reserves set aside for an emergency. If you haven’t already done so, open a separate bank account and save 3-6 months of living expenses in an Emergency Fund.
Consider using an online savings account linked to your primary checking account for this purpose. Knowing you have this money set aside for when life throws you a curveball will make it easier for you to remain disciplined with your personal financial goals.
Step 3 – Set a Savings Target
Once you make the decision to get started with investing, a normal follow-up question is “How much of my paycheck should I save?”
Unfortunately there is no right answer for everyone. It depends on factors like the number and timing of the personal financial goals or “whys” you listed above, how early you’re getting started and how long you plan to work.
Plan on setting aside at least 10% of your income if you’re getting started with investing in your 20’s and more like 20-25% of your income if you’re in your 40’s. My earlier article on this subject can provide you with more detailed guidance in this area.
Step 4 – Avoid Fee Factories
In a way, investing can be like giving to a charity. I’m sure you’ve heard the stories of charities that are so inefficient that only a small portion of your donation actually makes it to the people in need of your help.
You can think of your investments the same way. You’ll want to avoid two main types of inefficiencies that drain money from your account. Be sure to limit how much you are paying an investment advisor for advice and how much you are paying in fees for investment products. In his book, Money Master the Game, Tony Robbins offers a commonsense guideline of limiting your total fees to 1.25% of your annual account balance.
Investing in low-cost exchange traded funds and working with an advisor who charges you 1.00% or less annually to manage your investments will keep more of your money growing toward your personal investment goals.
Step 5 – Tolerate Short Term Pain for Long Term Gain
Everyone wishes that stocks and bonds would behave like a savings account not only in terms of paying out a guaranteed rate of interest but also never losing money. But if you’re already investing or listen to the news, you know that in any given year stocks can experience steep gains, steep losses and everything in between.
While we don’t know what will happen in a single year, the market has always historically delivered a positive return over longer time periods. In fact, with a simple portfolio consisting of 60% stocks and 40% bonds, investors have NEVER experienced losses over any 7 year period from 1928-2015. (Need to link this phrase to the “Use Patience to Guarantee Investment Returns” article that is set to publish on 4/26.)
While these historical returns are no guarantee of future results, having a long-term perspective will enable you to capture the superior returns offered by stocks and bonds and achieve the personal financial goals you established back in Step 1!
Original article published on Investopedia.