Now that you have decided that you want to grow an investments, choosing from savings, bonds, the stock market and other investment choices, how should you start?
Everybody is going to have different circumstances, with family, friends, commitments to social groups all pulling you in different ways. You may not always be in control of how you get to spend your money.
For example, if you hang around with people that earn more than you do, it may be difficult when they keep selecting to visit restaurants that are outside your price comfort range or are taking part in activities that cost too much. Children will always ask for the latest toys and can be another source of financial drain or emotional drain if you have to say “No” all the time.
Traditionally, you would not be entertained at a bank or stockbroker if you tried to invest less than hundreds at a time; the transaction fees alone could eat into your investment. But nowadays there are any number of low cost vendors that will allow access to investments such as funds or stocks so that you can start small. There is no excuse not to open an account.
How Often Should I Invest or Save?
The trick will be to time things to coincide with what you earn. Salaried employees get paid regularly and can use a standing order with their bank to move money into a savings or other account on the same day or date that they get paid. For wage earners, especially if the amount you earn is subject to fluctuations, like tips or overtime, you will have to use self control: decide on a percentage of what you receive to save and stick to it.
If you decide to save 10% then put that money somewhere else, such as a savings account, so that it is separate from the money that you pay all expenses from. If paid in cash, put it in a different compartment of your purse or wallet until you get to a bank. A jar or money box will also work, but you have to be careful about security. Don’t leave it too long before bringing it to the bank.
Another suggestion is to arrange to get paid your salary directly into a savings account. Before you take money out of the ATM you will have to first transfer it to your current account. That one extra step will often be just enough to discourage impulse buys, leaving more for your regular investments.
The first step is to start getting used to doing this. Don’t worry about where the money is kept if you are beginning. Just keep it separately for now and start saving.
What About Debt?
If you have credit card debt or use other expensive debt provision such as pay-day loans, and are paying at a high rate of interest, then you must pay down that debt first before even thinking about making a long-term investment.
Typical credit card debt can have exorbitant interest rates of anywhere between fifteen to twenty-five percent. Your best estimate of stock market return will be ten percent. It’s simple math to figure out that you will lose money if you try to invest while holding onto credit card debt.
Commit to the practice of taking a percentage of your earnings and paying down the debt first before all other expenses. And cut up those extra credit cards – you should be able to get by with one. If you continue to pile more purchases onto already overloaded loans you will never get out from under the pressure.
Not all forms of loans need to be paid off so quickly. A mortgage is a good example of where you might want to continue with it for many years, gaining leverage from borrowing from the bank. With interest rates at all time lows around most of the world, it makes sense to use mortgage borrowings to provide a place for you to live.
Most mortgage rates are well below five percent, so you can afford to invest some of your savings in the stock market and expect to increase your wealth over time while gradually paying off the mortgage, assuming a ten percent return.
Just remember to never miss a mortgage or loan repayment – talk to your broker immediately if you think you will fall short – and when planning your investment strategy, plan to save and hold in savings at least three months expenses including the repayment in case of trouble.
What about car loans? I would encourage you to avoid borrowing to buy anything like a car or equipment except in some exceptional circumstances. Try to save for the car or holiday or whatever. Figure out how long it might take? Will you really want it if you have to save for that long? Will it be worth it? Maybe your existing car or a local holiday will suffice.
It is simply too hard to justify borrowing at as high as ten percent when you could save up that cash and possibly invest it or just buy the luxury outright. Buy what you can afford to pay in cash. It might not look as good, but a second hand car that you can pay for with a little saving is a better option than a brand new one that comes with years of repayments attached. Maybe you can trade up after you make some money on the stock market.
This is the big question and will change from person to person. There is no easy answer. It depends at least upon on what your income and expenses are, what dependents you are providing for, what stage in life you are at, the political risks in your country and any economic risks relating to your income. There may be other factors to consider for your own personal circumstances.
It also depends on what you are investing for. What is you big goal? Let’s take a specific example of wanting to be a millionaire and assume that all saving or investing will be put into the stock market and that through some lucky break the investments attain the average return of about ten percent throughout the period.
The two factors we need to think about are how much and for how long does the investment need to be made. Let’s assume a static time of twenty years and a steady growth of the market with all dividend income included in our arbitrary ten percent rise by reinvesting them. Let’s ignore the taxes you may have to incur along the way (that‘s a big thing to ignore but we only want a ball park figure for now).
The amount you need to invest per month, given all the above is over 1300 per month to have a million under investment in twenty years. I think it just shows how hard it is to invest and save to become a millionaire starting at zero. Even if the markets go exceedingly well, you will struggle to get there.
Don’t despair. You can still grow a huge investment if you start now. Even by investing 100 per month under the same assumptions will return over 75 thousand over twenty years; not bad from a total of 24 thousand invested. Compounding will do wonders to your investment, but only given enough time.
How Much Really?
Anything is good enough to start. If you can save as high as ten percent of your take home pay before expenses, that’s great. If you can go further that could be better. If you can only put the spare dollars in your wallet each week, that is good enough to start with. But you must examine your own cash flow to determine the appropriate amount to save.
When to save is another interesting question. A strategy defined in Life Cycle Theory suggests that early in life you should borrow, do all the heavy investing during mid-life and reap the rewards later on. The aim is for whole-life happiness from the spending power you have. I'll post more about this later in the series. (Edit: Whole Life Happiness)
The next post will cover the process of planning, making and following a budget. Follow this process and it will will help to make it clear how much you can afford to invest each month. After you have created and followed a budget for a while and started saving or investing the money that it allows, you can begin to look at techniques to increase that amount, for example, reducing expenses or increasing income.
- Figure out what debt you have and the rate of interest on each loan or credit card.
- Make the decision to stop increasing debt and begin paying it off now. Start with the loan that has the highest rate.
- Decide if there is debt that you can live with for longer. This is usually mortgage debt at interest rates less than about four or five percent.
- Save something each week. Move it somewhere you cannot access it easily. Make it an effort to get at that cash. A savings account in another bank might work, one that does not allow internet or phone banking. You will have to physically go to the bank to make a withdrawal.
- When you have saved three months expenses and paid down all debt, start investing a small amount in stocks each payday. Choose a low cost index fund like the Vanguard S&P500 ETF, for example. And use a broker that has inexpensive rates.
- Check back here for the post on creating and following a budget to help you plan how much you can invest.