7 Principles to Help You Start Investing

We all have friends and family members who are investing money. Whether it’s stocks, bonds, real estate, or cryptocurrency we all know a few people who are investing. And this is a good thing.
 
Why? Because we can’t save our way to wealth or financial freedom. We must invest.
 
Although savings accounts may be “safe,” keeping all of our extra cash in those accounts may not be wise. Money sitting in a savings account won’t grow fast enough or accumulate quickly enough to allow us to meet our money goals. Plus, because of inflation, things cost an average of 2-5% more each year. This means that one dollar today will only be able to buy you 95cents worth of stuff next year. As things increase in cost each year, the amount of things you can buy for one dollar decreases, so you lose more and more purchasing power each year. In order to overcome this “inflation effect” we must find ways to make our money grow.
 
This brings us to investing.
 
Investing is when you purchase assets or things are likely to go up in value. Buying assets allows our money to make more money over time.
 
But… you must know what you’re doing.
 
Investing money without fully understanding what you are purchasing and how it works can cause you to lose money quicker than you think. Instead of feeling like you have to know everything about every investment, commit to learning a few of the basics:
 
Principle #1: One of the easiest ways to begin investing is in the stock market.
 
Unlike real estate investing which has lots of moving parts and requires a unique skill set and high startup capital or investing in cryptocurrencies that use newer technologies that can challenging to understand or who’s intrinsic value changes drastically, investing in stocks and bonds is often much easier.
 
Principle #2: When investing in the stock market, it is much safer to seek average profits with minimal risk of losing money than to aim for extraordinary profits with a high risk of losing money.
 
In order to obtain average returns (8-10% per year) with minimal risk, it is wise to invest in diversified index mutual funds. Let’s break down what this means:
 
A mutual fund is a group of investments (like a group of stocks or a group of bonds). Instead of buying one stock or one bond in a specific company like apple or tesla, buying a mutual fund means that you purchase a group of investments (that contains a percentage of stocks from apple and tesla and many other companies altogether). In other words, instead of one whole stock, you have a mutual fund that has a little piece of many different stocks.
 
An index mutual fund is a specific type of mutual fund (group of stocks or bonds) that follows an index. This means the amount and percentage of stocks that are contained in this group are similar to those that are tracked by other validated measures and meet a certain set of requirements. Examples of indexes are: the Standard and Poor 500 also called the S&P 500 (which is a list/index of the largest 500 companies in America). Because these mutual funds follow an index, they tend to be well diversified, which means they contain many stocks from different companies in various industries.
 
Principle #3: Investing in diversified index mutual funds has less risk than buying individual stocks.
 
If the value or stock of one company decreases, then stock in the other companies can lessen the impact of that decrease. Thus, with an index mutual fund the value of your investment tends not to change as often. Because you are have a percentage of stock in many different companies you have room to capture increases in stock value from many different companies at the same time. It is impossible to predict which companies will have stock that increases in value each year instead of staying the same or decreasing in value. Index mutual funds offer a shield of protection along with added opportunities for growth that combat this uncertainty.  Instead of having to buy individual stock in 500 companies, you can just buy the index fund and have a percentage of stock from all the companies for a much cheaper price. If the value of apple goes up, so does your investment. If the value of another company within that index fund goes up so does your investment.
 
Principle #4: Pick some of the most common index mutual funds and realize that different brokerages can have similar index funds that are called different names.
 
Many people may understand in theory what an index mutual fund is, but they may not know which one to invest in. In order to combat this problem many people invest in a lifecycle or target retirement funds. They may even pick a simple 3 fund portfolio (which means they invest in 3 different indexes at the same time). The goal is to invest in the index funds that have done the best over time, that are validated, that tend to have the highest returns year after year. That would be a combination of 3-4 different types of indexes:

• A Total United States Stock Market Index (an index that buys a percentage of all of the stocks in the United States)

• A Total International Stock Market Index (an index that buys a percentage of the stocks from companies all around the world)

• A Total United States Bond Index (an index that buys a percentage of almost all of the bonds in the United States)

• A Total International Bond Index (an Index that buys a percentage of almost all of the bonds from across the world)

 
You can get a version of each of these types of indexes at various brokerages (firms that allow you to buy stock). For example, the Total US Stock Market Index Fund at the Fidelity brokerage is listed under the symbol FSKAX and the Total US Stock Market Index Fund at the Vanguard brokerage is listed under the symbol VTSAX.
 
The percentage that should be invested in each of these indexes depends on the person.
 
Principle #5: The general rule of thumb is to have most of your money invested in stock index funds and a smaller percentage in bond index funds.

I have about 90% of my work retirement money invested in stock indexes (with 60% in the U.S. Total Stock Market Index Fund and 30% in the International Stock Market Index). I have the remaining 10% of my work retirement fund invested in bond indexes (with 8% in U.S. bonds and 2% in international bonds). What is right for me may not be right for you, so you should determine your own percentages.
 
Once you know why you must invest and you understand what to invest in, you must then understand a couple more things:
 
Principle #6: The stock market will experience ups and downs, but over the long haul, it continues to increase in value. It is better to invest consistently over time than to try to pick and choose the best times to buy and sell your investments.
 
Continuing to invest consistently despite the market fluctuations (changes in stock values from day to day) will prove to be more valuable to you than trying to “time the market” or invest only at certain times when the market is reacting in certain ways. It is more lucrative to buy when things are priced low (when the market is experiencing a downturn) and sell when things are priced high (so you can maximize your profit) but trying to time the market is hard to do since no one can predict the future. Attempting to time the market often results in lower profits than if you had just invested consistently over time because it’s nearly impossible to which days certain stocks will be low in value vs high in value.
 
Principle #7: Your money makes more money over time via compound interest so investing consistently over many years will help you to build wealth and meet your financial goals.
 
It often takes years to reach that first milestone of $100,000 but much less time to reach the next milestone of $200,000. Time is your friend. Trying to get rich quick often results in losses and can lead to poverty and debt. Be patient and consistent. Invest. 

Calculate your net worth and increase it

When it comes to personal finance, the ultimate goal for many people is financial independence. Financial independence is when you have enough money to do whatever you want in life and have control over your time. You can stop working if you want or cut back to part time. You can travel as you desire and afford to have incredible experiences with the people you love. In order to get to this state of financial independence you must be diligent with your finances and save/invest money in a smart way. Before you start investing money or begin your journey to financial independence, you must first figure out your starting point and calculate your net worth. Here’s how:

Step 1: Understand what net worth is

Your net worth is a number that tells you how much money you have. It takes into account the cash in your account and the things you own that you could sell for money. It subtracts any debts or loans you owe to others. In other words, your net worth is your assets (the things you have that are worth money) minus your liabilities (your debts).

Contrary to popular belief, your net worth is not how much money you make. Many people who make a lot of money assume they are “rich” but that may not be the case. There are those who make a lot of money but still have a low net worth (because they spend most of what they make and have a lot of debt). In contrast, there are those who make a “small” amount of money but have a high net worth (because they keep their expenses low and save/invest most of the money they earn). Knowing your net worth helps you know where you are starting from as you begin your financial independence journey.

Step 2: Make a list of your assets

The first thing to do to determine your net worth is to make a list of your assets. Assets are things that you have or own that are worth money. They usually fall into these 3 categories: Cash you have on hand (in a checking or savings account), investments you have (in stocks, real estate, or other currencies), and possessions you own that you can sell for money. In order to calculate your net worth, get out a sheet of paper (or open a file on your computer or phone). Write down all of your assets on one side of the paper and write down the value of each asset on the other side of the paper.

Some examples of things that can go on your list of assets are: the amount of cash you have on hand and in a checking/savings account. You also want to list investments you have in the stock market along with any investment money you have in your work retirement accounts (like a 401K or an IRA). If you have a home (or homes), write it down along with its estimated value. If you have a business, write down it down along with its approximate value. If you have expensive jewelry, a car that you own (leases do not count), or other things like furniture and equipment you can sell, then add those things to your list along with the estimated value of each of them.

Step 3: Make a list of your liabilities

Now that you have your list of assets you need to make a list of your liabilities. Remember, liabilities are things that take away your money. They are the debts you owe and loans you have. Things like credit card debt, car loans, house mortgages, student loans, business loans, medical bills, and other outstanding debts/bills are all examples of liabilities. As you make this list, be sure you are clear on what truly counts as a liability vs an asset, keeping in mind that some things like a car or a home may be examples of both.

If you have a home, the total value of your home will be listed under the asset column along with the amount of how much money the home is worth. If you do not own your home outright and are still making mortgage payments, then you would list your home again in the liability section and write down the total amount of the mortgage you have left to repay. For example, let’s say you bought a home last year. The purchase price was $180,000, you paid $20,000 as a down payment, took out a $160,000 mortgage to cover the rest of the cost, and that the value of your home has now increased to $200,000. In this example, you’d list the home in the asset column for its current value of $200,000 (because that is how much you could get for the home if you were to sell it). You’d then list your house mortgage in the liability column and write down the total amount of the mortgage you have left, which may be around $160,000. My point? Your liabilities column should list all of your current debts and loans (including your mortgage).

Step 4: Subtract your liabilities from your assets to determine your net worth

In order to calculate your current net worth, add up the total value of your assets and the total value of your liabilities. Then, subtract the total amount of your liabilities from the total amount of your assets. The number you get is your net worth. For example, if all of your assets equal $200,000 and all of your liabilities equal $150,000, then your net worth is assets ($200,000) minus liabilities ($150,000) which equals $50,000. For some people, doing that calculation may be quite surprising.

Don’t be alarmed if your net worth is negative. Many young professionals have a high amount of student loans or a large mortgage on their home that adds a substantial amount to the liabilities’ column. If the total amount of your liabilities is bigger than the total amount of your assets, then you have a negative net worth and a much longer road to travel to become financially independent. But don’t be discouraged. Calculating your net worth is good to get a baseline of where you are. Now that you know where you are you can determine how to move forward.

Step 5: Find ways to increase your net worth

Regardless of where you are starting from you can always get better. You can increase your net worth by buying more assets (or increasing the current value of the assets you already have). You can also increase your net worth by lowering your liabilities and paying off the debt/loans that you have. Take a look at your spending plan or monthly budget to identify ways you can increase your net worth. Perhaps you can start investing a larger amount from each check into your work retirement account? Maybe you can open a Roth IRA and start investing additional money on your own? You can decide to save more money from each check into your checking account by spending less or purchase other investments like real estates that increase in value. If you have debt and loans, you can try to make extra payments or larger payments each month to decrease the amount of money you owe at a faster rate. Regardless of which method you choose, make it a goal to increase your net worth. Choose one strategy to focus on over the next few months then recalculate your net worth after that time to see how much progress you’ve made.

My point? Calculate your net worth so you have a starting place on your journey to financial independence. One you have a starting point, identify a couple ways you can increase your net worth over the next few months.

Want to invest and build wealth sooner? Use Retirement Accounts

In the last few years there has been increased interest in investing. People from all over the world have downloaded apps like Robinhood to purchase stock in various companies. Some have even used the app to put money in alternative investments like cryptocurrency. Although this desire to build wealth is well-intentioned, there may be a better way to reach this goal: Retirement accounts.
 
Before you roll your eyes and write me off, hear me out (or I guess read me out). Retirement accounts aren’t just for middle aged and older adults who want to stop working in the next few years. Retirement accounts are useful for everyone. Although the original purpose was to help people invest money to use when they reached their 60s and 70s, retirement accounts can be extremely useful to you now, even in your 20s and 30s. The benefits you get by using retirement accounts can help you build wealth much more efficiently. You should consider using retirement accounts to invest money and become financially independent for the following reasons:

1. Using retirement accounts allows you to keep more of your profits– since you pay much less in taxes. Apps like Robinhood are considered taxable accounts. The money you use to invest is taxed, the profits you make are taxed, and the revenue you get after you cash out the investment is taxed. That’s 3 types of taxes! When you invest through retirement accounts you don’t pay nearly as much in taxes. Some retirement accounts like a 401K or 403b are tax-deferred. This means you delay paying any taxes until decades later when you take the money out. With other retirement accounts like a Roth IRA, you invest with money you earned and never have to pay taxes on the profit you make. Plus, you can take out the money you contributed at any time tax-free. My point? Using retirement accounts helps you save money because you pay less in taxes.

2. Using retirement accounts may help you get extra “free” money to invest – since you may get a contribution “match” from your job. Another perk of using retirement accounts to build wealth is that you usually get to invest more money. Retirement accounts are usually offered through your employer in the form of a 401K, 403b, or 457. As part of a benefits package at your job, your employer may offer a retirement account “match.” This is when the job gives you extra money, in addition to your salary, to invest in a retirement account. The amount they give you usually matches the percentage of your salary you choose to invest in retirement accounts. If you invest 5% of your salary, they will “match” your contribution with an additional 5% to put in your retirement account. With this match your job is giving you extra free money to invest with. Why not take advantage of this offer?

3. Using retirement accounts can lower your taxable income – which can decrease your student loan payments. Most of the retirement accounts offered through your job (like a 401K, 403b, or 457) are tax deferred. Since the money is tax-deferred, you don’t have to pay taxes on it until you take the money out years later. This means the more money you contribute to retirement accounts, the less money you owe when you file your taxes each year. It could even increase the amount of your tax refund. Since contributing to retirement accounts lowers your taxable income, it also lowers any income-based repayments that are tied to your income – like your federal student loans. The more money you contribute to tax-deferred retirement accounts, the lower your taxable income and the lower your federal student loan payments. Although interest will still accrue on your loans, this may be a good benefit for anyone currently enrolled in a student loan forgiveness program.

4. Using retirement accounts can help you invest on a more consistent basis – since contributions are connected to your paycheck. If you are a person seeking to invest more money to build your net worth and eventually have enough money to quit your job, pay for your kids’ college, pay off your home, or travel the world, you have to invest. You can’t merely save your way to wealth. Your money needs to make more money and grow. The only thing better than investing your money is doing so on a consistent basis. Year after year, month after month, make investing a habit. Make it routine. Make it automatic. One way to do that is to take advantage of an investment account that is already set up to help you make consistent investments – your work 401K. For some people it may be called a 403b or a 457 or perhaps they are self-employed and have an IRA or solo 401K. Either way, you have retirement accounts at your disposable and these accounts are set up to help you invest on consistent basis every time you get paid.

5. Using retirement accounts gives you more asset protection – since money in these accounts is protected from your creditors. Sometimes unexpected things happen in life. If for some reason you were sued, owed someone a lot of money, or happen to file for bankruptcy, your creditors could garnish your assets and take any money you have in banking accounts or in a taxable account like Robinhood. That is not the case when it comes to most retirement accounts. Retirement accounts offered through your job (like a 401K or 403b) offer much more asset protection because they are protected under the Employee Retirement Income Security Act (ERISA). This means your creditors cannot take the money you have in your work 401K to pay off your debts. If you are named in a lawsuit, the person suing you cannot go after the money you have in your 401K.   

My point? As you start investing, prioritize using retirement accounts. When you use retirement accounts you get better asset protection and more money from your employer. You also pay less in taxes, keep more of your profits, and can invest on a more consistent basis.
 

Want to Invest Money for Your Child? Consider a Custodial Account

Many parents want to set their kids up for financial success. One of the best ways to do that is to invest money on their behalf. Although there are many different investment accounts to choose from, consider opening a custodial account for your child.
 
What is a custodial account?
 
A custodial account is a type of account you can open to invest money on your child’s behalf. Technically speaking, there are two main types: A UGMA (Uniform Gift to Minors Act) and a UTMA (Uniform Transfer to Minors Act). With a UGMA, you can invest money in securities like stocks and bonds on their behalf. With a UTMA, you can invest in securities like stocks and bonds along with additional things like real estate or even put tangible assets like properties and businesses in your child’s name. A UTMA allows you to do everything that UGMA does, plus more. (UTMA’s are not offered in every state so some people are limited to a UGMA).
 
How does it work?
 
You call up a financial institution, like Fidelity, Vanguard, TD Ameritrade, etc, and let them know you want to open a custodial account for your child. The account will be in your child’s name and you will be the “custodian” or the person controlling the account. You then put as much money as you want into the account as often as you’d like to invest. Once your child hits the legal age of maturity (which ranges from age 18-21, depending on the state) they get all the money in the account. Some states like Florida, give you the option to delay the age in which your child gets the money until age 25, if you want.
 
What are the advantages?

1. It allows you to invest money for your child. By investing money, instead of merely saving it, you will be able to stack up more money for your child over time. If you saved $25 a month for your child starting from the time they were 5 years old, by the time he or she turned 21 you would have stacked $4,800. However, if you had instead invested that money (in index mutual funds which make an average of 10% per year) by the time your child turned 21, he or she would have $10,780. That is more than double what you would have if you only put the money in a savings account! 

2. It provides more flexibility than other investment accounts. Unlike other investment accounts that you can open for your child (like a 529 account or a Roth IRA), with custodial accounts there is no rule on what your child can or cannot spend the money on. If they decide to go to college, they can use it for college. If they want to open a business, they can use it for that. If they want to spend ½ of it to buy a home and the other ½ to pay for their wedding or fund a travel experience overseas they can do that too. It’s your child’s money to do as he or she wishes.

3. There is no contribution limit. With a custodial account there is no income limit on who can and cannot contribute to the account (like there is with an Educational Savings Account) and there also is no limit to how much or how little you can put into the account each year (like there is with a Roth IRA). It doesn’t matter if you are rich, poor, or somewhere in between, anyone can contribute any amount of money to a custodial account as frequently or infrequently as they want on behalf of their child. Contributions over $15,000 per year will trigger the federal gift tax, but technically speaking you can put as much money in the account as you want. That is not the case with some of the other investment accounts.

What are the drawbacks?

Like almost any type of account, there are things to be cautious of if you decide to open a custodial account on behalf of your child:

1. The money is your child’s to keep and you can’t take it back. If you are in a financial bind and need money for an unexpected car repair or to repay debt, you cannot withdraw money from the custodial account to do so. When you contribute money to the account you are legally giving the money to your child. This means you cannot take the money back later if you want to. It belongs to your child.

2. Your child can spend the money on whatever he/she wants. Once your child hits the legal age of maturity, it is their money to spend how they want. While this gives them lots of flexibility, it can be problematic without the right discipline. You may want your child to spend the money on college expenses or a home down payment but he or she may instead choose to spend the money on a fancy car, blow the money on drugs and clubs, or lose it all gambling. 

3. You have to report it on your tax forms and any financial aid forms for school. Since it’s an investment account that makes money, technically speaking, your child must pay taxes on the profit made from investing in the account. Any profits made in excess of $2100 per year is taxed at your (the parent’s) income tax rate. You can choose to pay taxes on your child’s behalf. You can also minimize any taxes owed by investing in low-cost index funds and simply waiting until your child reaches the legal age of maturity to sell any investments. However, if your child goes to college, he or she will have to report any assets they have (including money in this custodial account) to the school which may decrease how much financial aid he or she is eligible for. 

Given the drawbacks is it still useful?
 
Many people think so, but that’s a personal decision that you have to make for yourself. If you know your child will blow the money on drugs and parties then perhaps a custodial account isn’t the best place to invest the money. If you aren’t sure if your child will go to college or anticipate they may need money to pay for a wedding, buy a car, or start a business in the future, then perhaps a custodial account is a good place to invest money.

If you invest money in a custodial account then realize that your child wants to go to college (or think they may be irresponsible with the money in the custodial account) you can use the money to pay for college directly or transfer money from the custodial account into a 529 college account in their name. My point? Custodial accounts can be useful and you can invest in them in addition to other investment accounts like a 529 college savings account or a Roth IRA.
 
Tell me, would you consider opening a custodial account for your child? 

Beware: Your priorities can impact your lifestyle and net worth

When it comes to making money and living well as a young professional, we all have different priorities. Some people choose to spend a great deal on their family while others choose to live a fancier lifestyle or invest for their future. Although we may hope for more money, we may be stuck with our current salaries for the foreseeable future. Since we can’t rely on a large influx of cash, we have to prioritize spending money on the things that are most important to us. Although we have the freedom to choose what we want, the choices we make have a huge impact on our lifestyle and net worth. For example:

~If you prioritize living by yourself in the city… realize that this seemingly basic desire is considered a luxury. Many people want to live in the city close to various entertainment options and nice restaurants. They value having their own personal space and want the freedom to come and go as they please. Since many people have this same the desire, the demand for one-bedroom apartments in the city is high. Since demand is high, the prices are high. In my current city of Atlanta, a modern one-bedroom apartment in the city can cost around $1500 a month, if not more. Paying $1500 a month in rent may require a big sacrifice. It likely means that you cannot invest as much or save as much as you’d like each month.

~If you prioritize investing money for retirement… realize that doing so means the paycheck deposited into your account each month will be lower than it otherwise would. For a person making around $60,000 per year, who plans to allocate at least 10% of their income for retirement, their monthly take-home pay will decrease by about $500 per month.  For people who are already on a tight budget, getting $500 less each month may be a little too much to handle. For other people, the $500 per month is doable and they like knowing they are building their net worth and will be able to retire with enough money in the bank when they please. Retirement investing is vital, but it may require you to live below your means to a level you aren’t used to. You may have to decrease your bills by opting to live with a roommate or decrease the amount of times you travel.

~If you prioritize living a nice lifestyle (with fancy cars, good food, and lots of spare cash to spend)… realize this costs a lot of money. Choosing to live in a nice apartment or home will increase your monthly mortgage (or rent) each month. Choosing to lease or purchase a luxury vehicle may cause you to have a car payment that is well over $500 per month. Having spare cash to spend on concert tickets, frequent restaurant outings, and weekend bars can cost you hundreds of extra dollars as well. Although you have the freedom to live that lifestyle, understand that doing so may prevent you from being able to invest money for retirement. It may also preclude you from saving money in an emergency fund or being able to go on vacations without getting into debt.

~If you prioritize giving money away… realize this may require you to make a sacrifice in another area of your life. As a Christian, I tithe. This means I give away 10% of my income each month. While 10% may not seem like a lot, it’s a rather large chunk of my take-home pay. Because I give away 10%, that means I have 10% less money to invest, spend on housing, or use to save for a future vacation or wedding. To make up for this “loss,” I lived way below my means and shared an apartment with a roommate for 2 years until I was able to increase my income. Giving away money may be an important religious tenant for you as well. If so, think about how you can fit this financial priority into your current lifestyle.  

~If you prioritize saving money (for a nice vacation, future wedding, or house down payment)… realize this may require you to live in a cheaper apartment, invest a little less towards retirement, or be more frugal in your disposable spending. Perhaps you have a goal of saving $5,000 a year to finance a large international vacation and build up your emergency fund? This may require you to save an extra $400 a month. If you can’t figure out where to get the extra $400 you may have to get a side hustle or part-time job that can net you the extra money you need.  

~If you prioritize having a family (with children)… realize that although having a family with children can bring you joy, it may also add to your monthly expenses. With more people, you may need more space and need to rent a larger apartment or house. Because there are more people, you will also have to spend more money on food. If you have small children, you may have to allot a certain amount to daycare. All of these added expenses can amount to thousands of dollars per month causing you live a more frugal lifestyle and decreasing the amount of money you can allot to retirement savings.

My point? You may have to pick and choose what to spend money on. Until you increase your income, you won’t be able to do it all. Part of being a fiscally responsible young professional means that you have to prioritize your desires and figure out what’s most important.

• Does it mean more to you to build wealth by investing a large chunk of money for retirement or do you want your own personal space via a luxury one-bedroom apartment?

• Does it mean more to you to avoid going into debt by saving up for a fancy vacation ahead of time or do you want to live a nice lifestyle with expensive food, nice cars, and plenty of spare cash to spend on various forms of entertainment?

Part of being an adult means you have the freedom to make your own decisions and spend money how you see fit, but you can’t have it all, and neither can I. What are your priorities? What will you choose?