By Angela Epley
Putting your money to work through investing is one of the most important tools in your financial tool kit, not to mention a big milestone in your journey as an adult. But how do you know when you’re truly ready?
First-time investors often wonder how to get started — especially since most financial advisors agree that an investment plan is as unique as each person’s hopes and dreams for the future.
Investing is the activity of placing your money with a company, fund, or other financial vehicle in the hopes that you will get more back over time. In other words, investing is designed to increase the possibility of your money growing faster than it would in a savings account.
While both savings accounts and investment accounts benefit from compound interest (which happens when interest is added to the principal sum you invested, steadily snowballing into larger amounts), investing also incorporates risk/reward dynamics by participating in economic markets.
There is risk involved since the value of your investments will go up and down as the markets go up and down, but if you can train yourself to ride out the market swings, typically you end up with more money than you started with over a long period of time.
Make sure you already have an all-cash emergency fund that has enough to cover three to six months’ worth of your necessary expenses (like rent, utilities, etc.), and that you’ve paid off any high-interest debts such as credit cards and unsecured loans.
Why? The longer you put off paying high-interest debt, the more the interest continues to grow, and it’ll grow at a speed that outpaces the potential growth you might make on your investments. Plus, if you have a real emergency – like an unexpected veterinarian or auto mechanic bill – and you don’t have the cash to cover it, you may be tempted to reach for those high-interest credit cards to cover the cost, which puts you even deeper in debt.
If you don’t have a healthy emergency fund, and you do have some high-interest debt, you’ll do the most heavy lifting by paying down debt as quickly as possible, rather than by investing, which is a slow and steady process.
Once you’re on good financial footing and you’re ready to invest, you’ll need:
• Capital (a fancy way to say “money”)
• Goals (your dreams for the future that require money to become reality)
• Time (for your investments to grow)
• Specific accounts designed to hold investments (many of which have sweet tax breaks)
The entire act of investing relies on paying yourself first, or dedicating a certain amount of income from each paycheck to investing. Treat investing like a bill, and pay yourself before spending money on anything other than bills and essentials (such as food). This way, you avoid the risk of not having money left over to invest because you already spent on fun but non-essential “wants” like designer clothing, the latest electronic gadget or entertainment.
“Paying yourself first is a mindset or a habit pattern; it’s also is key to a solid financial foundation,” says Josh Andrews, CERTIFIED FINANCIAL PLANNER™ and advice director of investments at USAA. “Sometimes, we might get overwhelmed with a large amount of money that a goal like retirement needs. However, we need to remember that we are not saving for this over the next two years — it’s over the next 30 to 40 years.
“The key is to (1) start small, (2) start early and (3) stay committed. By taking those three steps, you can establish the habit pattern of saving or paying yourself first. Once it becomes a habit, it becomes easier to continue to save and increase savings as your financial situation allows.”
This is also why it’s so, so, SO important that you get rid of high-interest debts and have a healthy emergency fund before you get serious about investing. With this foundation in place, in a true emergency you can cover expenses with cash instead of adding to your debt load, or (even worse) raiding your investments and disrupting their slow and steady growth.
After you identify how much money you can comfortably set aside each month to pay yourself first, it’s time to define your investing goals: Are they short-term, like saving to buy a home in the next couple of years? Are they further out, such as saving for a child’s college education? Perhaps some of your goals are long-term, like saving up for retirement a few decades away.
It’s important to have clear goals that will not only serve as your motivation to continue setting aside money to invest each month, but also to determine what kind of investments you end up choosing. Investments with a higher risk/reward potential could be better choices for longer-term goals, but if you need certainty with your funds because they’re needed sooner, investments with lower risk/reward profiles may offer more protection.
There’s no getting around it: investments take time. There are no guarantees about what’s going to happen once your money is invested. What you can expect is that the markets will always be in flux. The value may go down at some points and up at other points, so give your investments enough time to weather this inevitable ebb and flow.
Investment accounts come in lots of flavors, and some even come with sweet tax breaks to help you get even closer to reaching specific goals.
Once you’ve got your basic building blocks squared away, it’s time to get started! Consider these four principles as you explore your investment choices:
1) Diversify your investments. If you take all the money you want to invest and put it in one company’s stock, you risk losing everything if that company has a bad year or goes out of business (Enron, anyone?). Diversification means distributing your money across a variety of investments, and not concentrating your dollars within a narrow selection. By diversifying your investments, you spread your risk across different options.
“Having a well-diversified portfolio may be the most important way for you to manage risk,” Andrews says. Another way of explaining this approach to risk management is that old saying: “Don’t put all of your eggs in one basket.”
Andrews adds that an experienced financial advisor may be able to assess current portfolio risk and, if necessary, help with suggestions to make sure it’s consistent with your risk tolerance and risk capacity, in addition to your long-term investment goals.
One way to diversify is across different areas of the market by looking at company size, or what’s known in the industry as “capitalization.” This can be done by investing in some large, some medium and some small-cap funds. You may also have some bonds (which is where governments owe you money — plus interest!) and different types of asset classes or industry sectors. Another way to diversify your investments is by location: look beyond the United States to invest overseas as well.
Remember, all of these approaches to diversification follow the same principle: if one area of the market is performing poorly and another is doing well, the poor performers won’t impact your portfolio as dramatically since you’ve got some good performers in there, too.
The world of investing holds many more options, so keep in mind that the fastest way help you narrow down what’s right for you and your goals is to connect with a financial advisor. Third-party professionals offer perspective and insight even if you’re still in the research stages.
2) Keep your emotions out of it. When it comes to investing, it’s important to remember that there are no guarantees. What’s happening in the markets today will be different than what’s happening tomorrow or five years from now. Rather than letting your emotional reactions to political changes – or what talking heads are saying about the markets – inform yourself about investment choices, be patient and level-headed and stick to an investment plan that aligns to your goals and timeline.
3) Know yourself. Some people love taking risks, and others are more conservative. If you’re fairly aggressive with your risk taking (and investments), you can expect the value of your investments will swing up and down a lot as the markets move, so make sure you’re comfortable with that. If you go a more conservative route, you’ll likely have less volatility, which means both less risk and less potential reward. Not sure where your risk tolerance falls on the spectrum? Search for online quizzes to help you gauge your risk tolerance — you might be surprised by the results!
4) Keep track of investment fees. Every time you buy, hold and sell an investment, you generally pay a fee for that privilege. Always take these costs into consideration as you begin investing, since some investments will have higher fees than others, even if they’re targeting the same area of the market. If you’re paying more fees for the same investment, those fees will eat into your growth, so be mindful: fees are the only thing you can control when it comes to investing. You can’t control the markets, but you can control your fees.
Remember that you can (and should) contact a financial advisor if you feel like you need a coach (or just a sounding board) to help guide your decision making, especially if you’re a first-time investor. Professional advisors are helpful in keeping your emotions out of the equation, pointing out pitfalls and opportunities that might not be obvious to first-timers, and they can make sure that you’re investing with a long-term strategy based on your goals (and not whatever antics the markets are up to).
Congratulations! If you’ve gotten this far and you’re ready to start investing, pat yourself on the back — you’re on the path to building lasting financial wellness and living your best life.
Ready to start investing? For more information, speak to a USAA financial advisor at 210-531-USAA (8722).
About the Expert: Josh Andrews is the advice director for Military Life Advice, Investments and Education and a CERTIFIED FINANCIAL PLANNER™ practitioner. Prior to joining USAA in August 2011, Josh served for 11 years on active duty in the Air Force. He currently is a lieutenant colonel in the Air Force Reserve, where he serves as the director of Air Force Academy admissions for South Texas.
This material is for informational purposes only and is subject to change at any time due to market or economic conditions.
Diversification is a technique to help reduce risk. There is no absolute guarantee that diversification will protect against a loss of income.
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