Do you want a surefire way to how to invest money? Do you want to get investing right on the first try? Having a solid framework to guide your first baby steps in investing is crucial to keep you motivated and engaged so you can reach your goals.
How To Invest Money: 5 Simple Steps That Work For Anyone
- 1 How To Invest Money: 5 Simple Steps That Work For Anyone
- 2 Step 0: How to invest money means how to save money
- 3 Step 1: How to set goals the right way
- 4 How to invest money for the iPhone you will buy in 21 years
- 5 Helpful tools that will set goals for you.
- 6 A critical note about financial goals
- 7 Step 2: How to pick the right investment account
- 8 Step 3: How to pick the investment portfolio to reach your dreams
- 9 Standard….what motion???
- 10 Next metric is the drawdown.
- 11 Picking the right investment portfolio
- 12 Step 4: Using the power of automation
- 13 Step 5: How you go from beginner to investment guru
- 14 Summary of how to invest money
Have you been told investing is only for professionals?
Have you been told investing is hard?
Have you been told investing will make you lose money?
Let me tell you right now that this is wrong, wrong, and, wrong.
I’ll guide you through the first 5 steps you need to take to get a good point of entry into the investment world. Investing is only hard if you let someone tell you it is.
When you have read the article you will know:
- Why you need to invest
- How you can do it.
- What you should do going forward.
Let’s get started with Portfolio Einstein’s How To Invest Money guide!
Step 0: How to invest money means how to save money
Ok, so I cheated a by adding a step 0. I’m sorry but you certainly won’t be when I’m done. I promise. Step 0 is just a primer about savings. I’ll make it short and worth your time.
In order to get started with investing you need cash. So saving is the name of the game. I usually recommend putting 10% aside from net income. This is not always possible but don’t let that stop you. If you can only spare 1% then put 1% aside. Every little bit helps in the long run. As long as you’re doing something you’re on your way to reach your goals.
10 dollars a month is 120 dollars in one year. That’s 120$ that you didn’t have when you started. Put the savings in a separate account that you don’t see every day.
Having savings is immensely important. Savings gives you options, builds confidence and ultimately gives you F.U. money if that’s the route you want to take.
Saving money is also the most important thing when you are just starting in investing. This is because the compounding effect of investment returns really kicks in after 10+ years. Getting a 10% return on $100 is $10 but getting a 10% on $100,000 $ is $10,000 – now we’re talking! The more you can save initially the more money will be able to compound over time.
Meb Faber recently made a post about savings vs. returns. He compared:
- Getting a return of 6% and saving 10%
- saving 10% and getting a 6%
Only after 25 years does the second scenario (higher returns) surpass the higher savings scenario.
Savings will save you.
Step 1: How to set goals the right way
If you don’t have any goals you’re already there. Goals don’t have to be super specific, but mentally this helps. You could have a goal to save 10% and see where that leaves you.
You need a plan and goal. However, as Mike Tyson stated:
Everyone has a plan until you get punched in the face
– Mike Tyson
Prepare for your plan to get sidetracked, demolished and changed but failing to plan is planning to fail. You need a plan.
If I always appear prepared, it is because before entering an undertaking, I have meditated long and have foreseen what might occur. It is not genius which reveals to me suddenly and secretly what I should do in circumstances unexpected by others; it is thought and preparation
– Napoleon Bonaparte
When John F. Kennedy, in 1962, proclaimed that the USA would put a man on the moon at the end of the decade there was no plan but there was a goal. A plan was quickly formed, however.
You need to have a goal to make your plan.
You need to have a plan to get to your moon.
The goal is a specific outcome, financial or otherwise. The plan is the series of actions that will get you there.
Types of goals include:
- Saving for retirement
- Saving for college
- Family trip to the Fiji island
- Getting a new car in 5 years
- Getting a new car in 10 years.
How you invest money is as much to do with practicalities as to why you invest money.
How to invest money for the iPhone you will buy in 21 years
The possibilities are endless when you start setting goals and especially financial goals. A great tool for helping you set financial goals is YNAB. It’s a personal finance tool that I use every day. It inspired me to make a super nerdy spreadsheet that attempts to list ALL the financial goals that I will encounter in my life till the day I die.
This is a fun exercise to do (at least for me!) and really shows the power of savings and compounding returns.
Let’s say I want to save for a new mobile phone that I will buy in 21 years. (I know I’m going to need a mobile phone in 21 years’ time, why not start saving for it?)
I’ll set my price for the mobile at 1000$ (it’ll be a lot more due to inflation). Using Bankrate’s saving calculator I need to put 2.54$ aside every month at 4% interest.
You can do this for all the things in your future life not just your big-ticket purchases. From the day we’re born we already have expensed coming our way. Why not plan for them and let the power of savings and compounding help us out?
Paul Merriman has a great article showing you how to turn $3,000 into $52 million by thinking ahead and putting savings and compounding to good use.
Helpful tools that will set goals for you.
If you need to calculate how much money you will have in x amount of years use a calculator.
This one from Bankrate lets you calculate how much you need to set aside each month to save for your goal.
For example to save $10,000 in 5 years (for your dream vacation) at 4% returns you need approximately to set 150$ aside each month.
You can also do this in Excel using the PMT function.
A critical note about financial goals
If you need the money within 5 years it is prudent to invest the money very conservatively. This means putting the money in a:
- Money market fund (VMMXX from Vanguard is good)
- A CD (certificate of deposit)
- A short-term bond ETF or fund, for example, SHY, BSV. If you have 3+ years it would be sensible to put them in a longer duration fund such as AGG or BND
- A portfolio with a heavy weighting towards bonds – at least 50%.
Let’s get your money working for you next.
Step 2: How to pick the right investment account
You need an investment account at a broker, mutual fund or a bank. Depending on where you are in the world either one of those will do. Here’s what you need to be aware of when selecting the right one:
- It needs to have low fees. That means low commissions (a max of $10 per trade) or even free. It shouldn’t cost a dime to transfer funds in or out of the account. They should be open about their prices on currency conversion.
- You should not be paying anything for having a portfolio at your broker or bank. Banks often charge a fee for holding your assets. This is an unnecessary expense.
- It needs to offer the right funds and ETFs. Make sure you can get Vanguard ETFs and/or mutual funds, iShares ETFs or Schwab ETFs. If they can’t provide any of those move on.
- It needs to be respectable. Don’t go with brokers or banks that are just getting started or have dents in their reputation. It is not worth, even if they are much cheaper!
- Consider using robo-advisors. Brokers such as Betterment and Wealthfront are great choices for your investments. Their portfolios are very good and they offer complimentary services that add value.
- Beware of bling. Many brokers and banks offer what I call “bling” services. Services that offer nothing more than extracting wealth from your savings. You need the basics covered first: Able to buy ETFs at a low cost. Automation such as auto purchase, auto-rebalancing, portfolio analysis etc. is bling. Don’t pay for it when you’re just getting started. Later when you have a good idea what you’re paying for you can check out the offerings. The exceptions are certain robo-advisors such as Betterment and Wealthfront which has the bling built in.
- Make sure the bank or broker provide some kind of help with your taxes. They almost all do this through various yearly statements and overviews.
Next up, the fun stuff – picking the right portfolio.
Step 3: How to pick the investment portfolio to reach your dreams
Now comes the fun stuff! Picking the right portfolio.
Depending on your time horizon the portfolio you choose will vary wildly. A 25-year-old saving for retirement has a very different portfolio requirement than a 42-year-old saving for a family holiday in 5 years.
At portfolioeinstein.com we have a lot of portfolios. Many of them or totally unsuited for your purpose. But many are very suitable. So which ones do you pick?
The first parameter you need to look at it the standard deviation. That’s the risk of the portfolio. This means how much the returns will likely vary from year to year. The higher the standard deviation the more the returns will bounce around. A portfolio with an average return of 1% and a standard deviation of 1% will vary it returns by 1% from year to year – on average. So a $100 savings portfolio with a 1% standard deviation is expected to move up or down by $1 each year.
To put it in other terms, the standard deviation describes the probability of how volatile the returns will be in a given year. The returns are distributed along a bell curve graph. This means that 68% of the time the returns will be within 1 standard deviation, 95% of the returns within 2 standard deviations and 99.7% of the returns within 3 standard deviations.
So when looking at the volatility (std) remember that you will experience those swings quite often.
Next metric is the drawdown.
This is the maximum amount the portfolio has historically lost in a year. In my opinion, this is a better metric of risk than standard deviation is. Note that the drawdown is measured at year’s end. The drawdown in mid-year could actually be higher. This was the case for S&P 500 in 2009 where it had bottomed out losing a total of 50.8% since 2007. In a single year, however, the S&P 500 has “only” lost 37%. It has since regained what it lost during those years and gained a massive 250% since then.
The drawdown metric if very important as not many investors can stomach a drawdown of more than 25%.
The final metric is the return metric. This is dazzle statistic and that which what everyone looks at first. But the risk metrics are more important as you will not get the returns of the portfolio if you don’t stick with it.
The best portfolio is the portfolio you can stick with.
Picking the right investment portfolio
If you have a goal ready you know how much time you have. Using the Bankrate calculator you will know the approximate amount of returns you need to achieve your goals. That will help you in deciding what level of risk you should take. There is no need to take more risk than you need to!
If you are unsure about which portfolio to choose Portfolio Einstein recommends you start off with the three-fund portfolio and adjust the bond portion to suit your risk level. Advantages of the three-fund portfolio:
- Is easy to understand.
- Generate good returns
- Is highly configurable if you want it to be.
After you picked your portfolio go to your broker and buy the recommended ETFs or mutual funds. If you need the correct allocation you can use our rebalance tool.
That’s it! You’re on your way to mastering how to invest money and beating the best!
Now its time for a little talk about thinking long-term and keeping up your momentum.
Step 4: Using the power of automation
Whenever you can you should take advantage of any way to automate your savings and investing setup.
At the very least you should set up a recurrent transfer from your deposit account to a savings account to keep your savings separate from your “normal” income. Best of all is to send the savings amount to another account you do not look at regularly. It prevents you from dipping into it when you see how rich you have become!
The next thing you want to do is set up an automatic investment process. If your broker bank or mutual fund support automatic investment make use of it (but check their fees first!) This is highly recommended! For US residents there are a lot of options for this: Vanguard, Schwab, and Fidelity offer this feature as does a lot of brokers. Automating the practicalities makes sure that your money really does get invested regularly.
Step 5: How you go from beginner to investment guru
Now that you are on your way to reaching your goals let’s make sure you stay on the path.
If you have set up an automated process for savings and even for investing your money you are 95% done!
There are still a few things left to do:
- If you haven’t set up an automated investment process set up an “investment day” in your calendar where you buy the funds for that month. It should take no more than 10 minutes.
- Rebalance once a year. Check this post on how you rebalance your portfolio. The act of rebalancing can give you more money while at the same time lowering the risk of your portfolio.
- Look at your account balance only when you need to. Fidelity made a study showing the best performing portfolios where the portfolios of dead clients and clients that had forgotten they had an account. Lesson to be learned: Don’t look at your portfolio balance because you will be biased for action if things don’t go the way you imagined them.
- When you check your account balance do so with your goals in mind. Increase your savings if your investments haven’t turned out as expected. The worst that can happen is you over save (that’s a good thing).
- Read a few books on investing to further your investing knowledge. Go here for some good recommendations.
- Email me or better yet, make a comment below if you have any questions – others have the same question.
And joy is, after all, the end of life. We do not live to eat and make money. We eat and make money to be able to live. That is what life means and what life is for.
– George Mallory
Summary of how to invest money
Congratulations on completing the 5 steps to how to invest! Do you agree that investing is not hard? Even a complete beginner with less than one hour of training can do better than most professionals. It all starts with setting the right goals so you can start moving towards them. At Portfolioeinstein.com we have ready-made portfolios to go. You just need to open a brokerage account and buy the funds we recommend for that portfolio. After that, your portfolio should be on cruise control with yearly checkups for rebalancing and adjusting purposes. This is how you invest money!
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