Photo by Alexander Mils on Unsplash.
Investing will be discussed continually throughout the blog. I feel it is important to give you a taste at this point before we get too far down the road. Recall that investing is a simple formula just like losing weight. Losing weight is eat less and move more. Investing is all about making more money, spend less and invest the difference.
If you are reading this, the assumption is that you are close or you already have your debt paid off. If you haven’t created your budget and paid off your debt, then you should go back and complete those two tasks first. Then come back after your debt is under control.
The first thing that you must learn is that your house is not an investment. Too many times people will leave college and go out and buy a car and a house and think that they are setting themselves up for life. Well, there are a few issues with this thinking. The thought behind this is that we all know of stories where our parents or grandparents bought a house 30, 40 or 50 years ago and when they eventually sell their house or leave it to their heirs, there appears to be a windfall. This is a bit misleading and if you compared the funds spent on the house vs other investments, you will see that the gains are not all that great. We will go into the numbers in a later blog entry.
Today’s lifestyle is much different than that of our ancestors. We tend not to live in houses for more than five years. It is difficult for appreciation to cover the closing costs of the buy and sell in such a short period of time. Especially if you consider that interest rates are low. Also, should you lose your job and cannot make the payments, the house does not put money in your pocket. True assets bring a regular return on investment. Also, consider the fact that if you do not pay your property taxes then you will lose your house. So do you really even own your house?
The very first investment people come up against is the 401K. Most W2 jobs at this point have some type of 401K. When I say W2 job, this is just another way of saying that your work for someone else. If you are self-employed then you can open up a solo 401K, SEP IRA, or ROTH IRA. This can be a great way to go as you will obtain help with the growth of your account by compound interest on the tax deferred portion of your salary that remains within your account. A good rule of thumb is that you should at least invest enough into the 401K to obtain any matching that your company provides. Of course matching doesn’t apply to the self-employed.
If you are not investing elsewhere then you should start with your company’s 401K. If you are investing elsewhere then you should run an investment comparison study to determine which investment entities bring you the best ROI (return on investment). You may even determine that you can invest in both your personal investment and the 401K. Run the numbers.
The first issue that blocks and confuses people is how to allocate the funds in a 401k. By allocate, it means to determine what funds you allocate your savings to. The fund names across 401K accounts tend to be similar. You will hear things like small cap, large cap, fixed assets, index funds, etc. For the best advice on this one, I would recommend that you read JL Collins book entitled the Simple Path to Wealth by JL Collins. I’ll summarize what JL recommends here. Invest 75% in Vanguard’s VTSAX and 25% in VBTLX. This savings rate is what is used in the 4% rule and is based on William Bengen’s analysis of what investing rates should be to make ones portfolio last 30 years with a reasonable rate of success. I have paraphrased the 75/25 investing rate here so you can reference JLCollins and William Bengen to draw your own conclusions on the investing rates.
If your 401K does not have access to Vanguards accounts, then read through each of your potential investments and pick one that is based on investments that make up the S&P 500. The VBTLX is a bond fund and you should be able to find a fund that invests in a broad spectrum of bonds. With the current low interest rate environment, bond investments will not fare well so you may want to consider increasing the equity (VTSAX) portion of your investing. So maybe a 80/20 or 90/10 investment of equity to bonds may be considered.
The second issue that usually confronts people beginning their investments is the amount they should invest. A lot of financial advisors would say 15%. It turns out that this is a number for those who plan to retire at 65. We’ll tackle the math behind this at a later date. If you don’t have 15% to invest then try to invest as much as possible to obtain the employer match and then slowly increase the amount your save keeping the 15% as your target. If you can save and invest more than that then go for it.
I can remember in one of my earlier jobs, we used to share investing strategies with one another. We would make fun of one another and other people who didn’t know what percentage of their salary they were saving. That persona became a “loser” in our minds. We never heckled the person directly, but it was used as a prod within our group to compete for the highest savings rate.
Should this savings rate be before or after tax or another way to say this is your gross pay or your net pay. Once again start out with your net pay since that is less and build up to 15% of your gross pay. I can recall that I was saving 45% of gross pay and 54% of net pay at the time. One might think that this severely impacted my life, but it really didn’t. I still enjoyed life just as I always have.
Note that this is the beginning of investing. We will have a lot more to discuss as we master our personal finance. As always, consult with your mentors, tax and financial experts.