Maybe you landed the killer promotion or destroyed some debt, and now you finally have some free cash flow.
Congratulations! Now it is time to learn how to invest money like a boss.
Now you’re ready to save and invest. But you’re not sure how to invest your money. I have good news.
I’m going to introduce you to six basic steps on how to invest your money. It will be unlike many of the other “how-to” articles on investing.
Before you think about investing a dime, we need to set the foundation. Without it, it will be difficult, if not impossible, to have a successful investment strategy.
I’ll list the steps first and then get into some detail to help you navigate each one.
- Set your financial goals
- Work from your budget
- Determine how much you can save/invest
- The best accounts to start – taxable vs. tax-deferred
- Find the best investment options.
- Get started
- Monitor and rebalance
Now let’s get into the details for each to get you started.
Table of Contents
How to Invest Money Like a Boss
Personal finance principles are not complicated. Executing them takes practice and discipline. If you want to build wealth, you will need to do these three things:
- Spend less than you make
- Save and invest the difference.
- Reduce or eliminate debt
These are common sense things. Living within our means, being disciplined about saving and investing, and minimizing debt, will allow us to build wealth over time. There are no get rich quick schemes that work. There are no short cuts. Doing these three things over a long period will give you the best opportunity to build wealth.
Here’s where to start.
1. Set Your Financial Goals
The first step you need to take before investing your money is setting some basic financial goals. This is typically the first step in every financial planning process out there.
For nearly everyone, that should include a retirement goal. You should set a rough plan for what age you want to retire and how much money you wish to retire.
The age is 100% your call. Most people retire in their 60s, but there’s no reason you cannot work longer. And if you want to retire earlier, you’ll need to save and invest a little more along the way.
When it comes to how much money you need in retirement, you can use a simple trick to find your number. It’s called the 4% rule.
The rule works by simply taking your living cost and dividing it by 0.04 (or multiplying it by 25). So if your cost of living, including rent, groceries, and all other expenses, is $20,000 annually right now, you will need $500,000 to retire comfortably (assuming your cost of living stays the same).
If your cost of living is $40,000, then you’ll need a million dollars.
Retirement isn’t the only financial goal you should consider. Other goals to consider before investing are:
- Paying off debt
- Building an emergency fund
- Saving for a vacation
- Saving for a car
- Preparing to buy a house
- Saving for a child’s education
- Building wealth
While the list is not exhaustive, it’s a good start.
It’s important to understand these goals because they may impact how you invest. For example, if you currently carry a lot of high-interest debt, you might prioritize paying that off before investing.
Similarly, if you are saving for a car or house, you’ll have to balance how much you plan to invest versus how much money you put into another bank account for those items.
2. Work from a Budget
I know, I know. Talking about budgets is about as much fun as having a root canal. But if you don’t know where your money is going, it will be challenging to save and invest consistently. I’m not suggesting you need to be slaves to your budget—quite the contrary. But you need to know where your money is going every month to know to analyze areas where you might reduce expenses and increase the amount available to save and invest.
Many people use spreadsheets to budget. If you’re not a spreadsheet person, consider some of the budgeting apps available. Mint.com and You Need a Budget (YNAB) are two of the most popular. Both programs allow you to connect your bank accounts to pull expenses into the app. You can then set up categories to better manage where cash is going.
If you’ve been disciplined enough to pay off your debt, you likely have some budgeting mechanism set up. If not, these two apps can help you get started.
3. Determine How Much You Can Save/Invest
Your budget tells you how much you can save and invest. That’s the foundation that must be in place to ensure you can contribute a consistent amount to grow your wealth.
If you want to save and invest more money, increasing your income means you have more to save and invest. If you’re working in a corporate job, look for ways to get promoted, update and improve your resume. Learn the art of negotiation when asking for raises. Become more valuable by working harder and doing more than what’s asked of you.
Look for ways to gain income outside of work. Find a side hustle or part-time job that has flexible hours and can bring in more money. The more money you make, the more you can save and invest.
If money for an emergency fund is not part of your budget, it needs to be. What’s an emergency fund? It’s money you keep in a liquid (risk-free, penalty-free) account that you can access at any time. Use this money to pay cash for unexpected expenses. If your car breaks down, you have an unexpected medical bill, or any other expense, don’t pay for these on a credit card. Use the cash from the emergency fund.
The emergency fund should have a minimum of three to six months of monthly expenses in it. So, if your monthly expenses are $1,500, you would keep from $4,500 (3 months) to $9,000 (6 months) in the account. If expenses are $2,000, you’d keep $6,000 or $12,000 in it.
Some people keep one or more years of expenses in their emergency fund. Whatever amount you choose, be sure not to compromise that number. Financing unexpected expenses on a credit card will put you right back into the hole you just dug out of.
After the emergency fund is in place, look at what’s leftover in your budget. The money to invest will come from money left after bills are paid and your emergency fund is full. If that amount is zero (it shouldn’t be), then it’s time to look at where you can cut some costs.
Since you’ve had the discipline to pay off debt, you’ll likely have a reasonable sum of money for investment.
4. Find the Right Type of Account
Most people thinking about how to invest their money should look at retirement accounts first. Remember, this is after you’ve set your budget, created your emergency fund, and determined how much you can invest each month.
If you have a career, your company likely offers its employees a retirement plan. These go under different names – 401(k), 403(b), etc. The programs provide a way for employees to contribute money every paycheck to an investment account where the money invested grows tax-free as long as it remains in the plan.
In most cases, the employer contributes money to your account as well in the form of a matching contribution. They agree to match what you put into your account with their own money up to a certain percentage.
Here’s a typical example. They offer to match your contribution up to 50% of the first 6%. For every six dollars you invest, you’re getting three dollars more from the company. That’s a 50% return on the first 6% you put into the plan. There is no other investment out there that offers a 50% guaranteed return.
Plus, the money you contribute is tax-deductible, meaning it reduces your taxable income by that amount. You pay tax on the money at the time you withdraw it at retirement. It’s free money and a tax deduction. It’s truly the best investment you can make.
The IRS allows you to contribute up to $19,000 of your own money into employer-sponsored plans. That means you can put a chunk of money toward saving for your retirement.
It would help if you also considered contributing to a Roth IRA.
Unlike employer plans, contributions are not tax-deductible. The money you contribute to a Roth IRA has already been taxed. You can contribute $6,000 to a Roth in 2019. Earnings on the money while it remains in the account grow tax-free.
You can withdraw contributions at any time without penalties or taxation. Earnings are a little different. If the Roth account is five years old, profits can be taken out without paying any taxes. However, if you are under age 59 ½ at the time you withdraw, you will pay the IRS a 10% penalty.
The great thing about a Roth IRA, especially if you start one when you’re younger, is that money withdrawn after five years and when you’re over age 59 ½ is tax-free income. That’s a huge benefit when you’re calculating retirement income.
Having tax-efficient or, in this case, tax-free income in retirement is a significant advantage of the Roth IRA.
5. Find the Best Investment Options
If you’re investing in your employer’s retirement plan, the options you have are the ones available in the plan.
In the vast majority of plans, these are mutual funds.
In their basic form, mutual funds are managed portfolios of stocks and bonds. They are professionally managed, offer some diversification and a variety of choices in the types of stocks and bonds available. Most plans have a lot of choices (sometimes too many) of funds. Your benefits department can provide information to help you decide which funds to select.
For any money you’re investing outside of the employer plan, mutual funds are also an excellent option. You aren’t limited to a set of funds chosen by your employer. In many cases,m you can buy mutual funds that are lower-cost funds offering better performance.
There are other options to consider, as well.
Individual Stocks and Bonds
In mutual funds, the fund managers decide which stocks and bonds to invest in and often invest in hundreds of stocks. You can also buy individual stocks and bonds on your own. When you’re just starting out investing and have smaller amounts of money, it’s hard to diversify a portfolio of individual stocks. It takes a significant dollar amount to buy enough stocks to diversify your portfolio.
Picking stocks and bonds on your own is also riskier. Stock market investments should only be considered for those with a high-risk tolerance. If you have a low-risk tolerance, consider the options listed below.
There are a variety of stock picking newsletters and services to help you make a choice. Many of these services tout their ability to beat the market and provide higher returns. If you’re learning how to invest or just starting, I would not recommend individual stocks and bonds.
If you’re up for taking on more investment risk, it may make sense for you. Individual stocks are a high-risk, high reward proposition.
Index funds are a specific type of mutual fund. As we described earlier, funds have professional managers who decide which stocks to buy and sell based on their research. Index funds do just the opposite.
Index funds invest in unmanaged indexes made up of hundreds of stocks. The index you’ve likely heard of and are familiar with is the S & P 500 index. The index is made up of the largest 500 publically traded companies in the U.S. The size of the companies is based on the market value of their stock. The larger companies have a much more significant impact on the return of the index.
An S & P 500 index fund invests in all 500 of these companies. Managers don’t decide on how much to put into each company. Instead, the amount they put in each aligns with each company’s size to the total index. There are dozens of stock and bond indexes available for investment.
Index funds are among the lowest cost funds you can own. The lower costs mean more of your money gets invested. Expenses on professionally managed funds are much higher than index funds. Returns of index funds outperform professionally managed funds about 75% to 80% of the time.
For most people, index funds are a great option.
Robo Advisors (Automated Investments)
Robo advisors are a relatively new entrant to the investment landscape. They’re called robo advisors because they use algorithms to build and manage portfolios. These technologies automate the investment process. The investment vehicle most use to create their portfolios is exchange-traded funds (ETFs). ETFs are, in many ways, like mutual funds. They pool together investor money and purchase a diversified portfolio of stocks or bonds.
Unlike mutual funds, ETFs are bought and sold more like stocks. I won’t get into the details of how they work here. The main point is that ETFs can be bought and sold during the day. They provide more flexibility in buying and selling shares. Robo advisors like that feature of ETFs.
ETFs also give robos the ability to diversify their portfolios at a low cost. Investing with one of the many robo advisors offers a ready-made, broadly diversified portfolio of stocks and bonds. Most of them require investors to complete a short risk questionnaire to determine which portfolio is a good fit.
The best online brokers for you depend on many of the factors already mentioned. Whatever you choose should fit what helps you best meet your financial goals.
Bonus Option: Financial Advisor
Lastly, you may need a financial advisor. You can always find a financial advisor to invest on your behalf. This option is typically the most costly, and you should be cautious about choosing an advisor who has your best interest in mind.
Compared to a robo-advisor that charges around 0.25% in management fees, it is not uncommon for some financial advisors to charge a 1% management fee or more.
6. Get Started!
At this point, you’ve done most of the important legwork to start investing your money! Even if you have a little money to invest right now, you can get started today with only $100.
Taking action involves three important steps:
- Open your account
- Fund your account
- Make your investment purchases!
I’ve heard horror stories of people opening up a Roth IRA and depositing money into the account, thinking they had invested their money. But they never actually invested in an asset class!
The money was sitting in the broker’s account, similar to how it would sit in a bank account.
Once you fund your account, you need to make your investment purchases, whether it’s for a stock, index fund, ETF, or anything else, don’t forget this step in the process!
Note: Diversification is Crucial
In its simplest form, diversification means having your money invested across different asset classes (stocks, bonds, cash) to lower the risk of owning individual securities. With mutual funds, investors who own three or four different funds get fooled into thinking they own a diversified portfolio. In reality, they may not.
If the four funds all invest in large, U.S. based companies, they have four funds with lots of companies all in the same asset class (large U.S. companies). True diversification means having money spread across many different asset classes (large stocks, small stocks, growth stocks, value stocks, etc.). That diversification applies to bond investments (short term, medium term, government, corporate).
It’s next to impossible with regular monthly investments to get proper diversification with individual stocks and bonds. And with mutual funds, you need to have a good understanding of the asset classes and how they work together.
To that end, when you’re learning how to invest or investing smaller amounts of money, your two best options are index funds or automated investment programs (robo advisors).
They allow you to invest smaller amounts of money in a broadly diversified portfolio. With robo advisors, there is also some effort in finding a portfolio that fits your risk tolerance.
8. Monitoring and Rebalancing
Last but certainly not least comes the need to monitor and rebalance your investments.
As the name suggests, monitoring means watching the investments to make sure they are doing what they said they were going to do. It’s making sure your diversification and mix of investments stay close to where you wanted it to be when you started. If it sways from that mix, you could be taking on more risk or compromising the performance you wanted when you started.
Rebalancing means that if parts of your portfolio grow or fall in value beyond what the managers targeted, you should sell those that have gone up and buy the ones that have dropped. In other words, bring the portfolio back into the balance (mix of stocks, bonds, cash) you designed when you started. Rebalancing does not need to be done every month.
In fact, once a year is probably enough. With markets going up and down a rapidly as they do these days, the market often rebalances the portfolio on its own with its up and down moves.
My thoughts on investing were targeted to those who may be just learning how to invest. It’s also applicable to those who may have some knowledge of investments but not a lot of money. Either way, I hope this helps you make smart decisions about your money.
I’m one who believes that the best way to invest in today’s markets is to own the market. The best way to do that is through index funds or robo advisors. These two options are low cost. They offer an easy way to own pieces of the entire market. There are index funds available for any market, stock, or bond, around the world.
Please take advantage of employer plans and Roth IRAs to the extent they are available. Be consistent with your investing. Put money in regularly in good and bad markets. Keeping costs low, owning a broadly diversified global portfolio, staying invested in that portfolio, and periodically rebalancing as needed will bring you investment success.
There are no guarantees when investing. Following this formula offers you the best chance for investment success.
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