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How to start investing

How To Start Investing With Justin Krane

In our continuing back to basics series, we teach you how to start investing with Justin Krane.

Many people are afraid of investing so we’ll explain the basics of how to start investing because the earlier you start, the better.

What is Investing?

Warren Buffett has perhaps the best definition of investing, “The process of laying out money now to receive more money in the future.” Investing earns you passive income. There are only so many hours in the day we can use to work for our money so we have to find a way to earn money that doesn’t take much or any effort from us.

There are many ways to invest your money; stocks and bonds, real estate and they all have pluses and minuses.

How to Start Investing

This is what trips a lot of people up. Investing seems like this mysterious, complicated thing that the average person can never possibly understand. Well, yes and no. There is a lot you can learn about investing that can make you more successful. But you don’t have to know any of it to simple start investing.

Do you have $1? Good, then you can open a Betterment account and start investing right this second. You just answer a few simple questions to determine your risk level (a higher risk portfolio will be more heavily weighted toward stocks than bonds), connect your bank account information and that’s it. Viola, you’re an investor!

Debt vs Investing

If you have debt, should you invest or wait until the debt is paid off? We get this question a lot and it’s a good one. The answer largely depends on what type of debt you have and how much the interest rate is. If you can make more through investing, you can expect to average about a 7% return a year, then you are paying in interest on debt, then the answer is yes.

If you have low interest debt like federal student loan debt or mortgage debt, then yes. You should be investing. If you have high interest like credit card debt, it’s better to focus on paying that off first.

Justin made an interesting point though. He advises that we do both, invest and pay off debt at the same time. When you are slogging away paying debt, it can be easy to get discouraged. You don’t have anything to “show” for the money that went to pay the debt off. When you do both you can at least see some progress in your financial life because you see your money growing in an investment account.

Does this always make financial sense? Not if the interest on your debt is higher than what you can earn through investing but humans are not always rational creatures, often we are emotional creatures. That’s why for some of us it’s better to use the snowball method of debt repayment than the stacking method. The stacking method saves you money but the snowball method gives you emotional wins and that’s not something to poo poo. Those emotional wins can help us keep up our motivation.

Another scenario where it makes sense to invest while you have debt is if your employer sponsored 401k offers matching. That is literally free money and you should never walk away from free money.

Diversified

Being diversified means spreading your investments out in order to reduce your risk. The old cliche about not keeping all your eggs in one basket. You want several different kinds of investments; stocks, bonds, real estate, cash. And within those categories there should be further diversification.

You should own stocks in companies across several different industries, tech, health care, energy, etc and a mix of domestic and international companies within those. The bonds in your portfolio should include US Treasuries, municipals, foreign bonds, and emerging market bonds.

Individual Stocks

If you’re new to investing it’s easy to invest through a robo advisor like Betterment or Wealthfront. But as you learn a little more, you might want to invest in individual stocks. It’s riskier than investing in an index fund but the rewards can be greater.

If you know nothing about investing but want to buy individual stocks, start by buying what you know; products you are familiar with or companies with whom you do business. If you love i Phones and Macs, buy Apple. If you love Amazon, buy Amazon.

But because it is riskier to buy individual stocks than to buy through an index fund, just make it a small part of your portfolio. Just invest an amount of money that you could easily absorb if you lost it.

Compounding

The real magic of investing is compounding interest. Compound interest is interest you earn on your interest. That’s hard to understand, here is an example.

If you invest $10,000 at 7% interest for 20 years without adding anything to the initial investment, that $10,000 will turn into $38,696.84. You didn’t do anything to earn that extra money, you didn’t even add anything to your initial investment and like magic, you end up with an extra $28,696.84!

That’s the power of compounding interest and why it’s so important to start investing early.

Dividends

When you own stock in a company you may receive dividends. A dividend is a distribution of a portion of a company’s profits. They are decided by the board of directors and can be issued as cash payments, as shares of stock or other property. It’s an opportunity for a company to reward shareholder loyalty.

Investors, particularly retired investors, like the steady income that dividend stocks provide and also like the option of reinvesting dividends to buy more shares of stock. Dividends are a form of passive income.

Rebalancing

Your portfolio has a certain asset allocation. An example would be 50% stocks and 50% bonds. That allocation can change. If bonds are doing well and stocks are doing poorly, your allocation is no longer 50/50.

In order to rebalance, you need to sell of some of your assets and buy some others to bring your portfolio back into balance. If you have $500 in stocks and $500 in bonds and you lose $100 in stock value, you take $100 from your bonds and buy stock.

That sounds crazy. Why would you take money from something doing well and put it into something doing poorly?! Because Rule #1 of investing is buy low and sell high. Stocks are low so now is the time to buy. Bonds are high so now is the time to sell.

You may pay capital gains taxes when you sell investments but that can be mitigated through tax loss harvesting which companies like Betterment and Wealthfront do for you automatically.

Retirement Accounts

Part of your investments should be in retirement accounts. For many people, the 401k they have through their employer. This is a good way to start saving for retirement, it’s “forced” savings and as we mentioned above, if you have matching, it’s free money.

A Roth IRA is another retirement account you should have. You invest after tax money and can’t touch the earnings (but you can access your contributions) until age 59.5. After that age, you can withdraw the money tax free. We don’t know how high tax rates will be in the future but we do know what they are currently and that is the reason many advisors recommend a Roth IRA.

Fees

People have no idea how much of their retirement money they are losing to fees; it can be as much as one third of your money!

You might know what percentage you are paying but how much is that in real dollars? The average actively managed fund charges 1.25%. That doesn’t sound like much but over time, it adds up.

It adds up to a lot. If you invest $100,000 in a fund with a 1% annual fee, which is less than average, it will cost you nearly $28,000 over twenty years, according to Securities and Exchange Commission calculations. If you had that $28,000 to invest, you would have earned another $12,000.

Under 1% is a good percentage to look for and you’ll find fees that low and lower with Index Funds and ETF’s. The average traditional index fund has a fee of 0.74% and the average ETF fee is 0.44%. Vanguard’s lowest fee fund is the Vanguard 500. The fee is 0.17%. Betterment charges a fee of 0.35% on the first $10,000 invested.

Roll Overs

When you leave a job, you should bring your 401k with you. You will have more options for better investments with lower fees. It’s also a mistake to have money scattered all over, it makes it hard to manage and keep tabs on.

Open a Roth IRA if you don’t already have one and tell your 401k plan that you want a direct rollover. They will send the money directly to your IRA and not to you directly which is important for tax reasons.

Emergency Fund

Just as important as investing is having an emergency fund. An emergency fund is 3-6 months worth of expenses that you keep on hand in the event of something like a job loss, a medical, home or car expense.

Not having one when disaster hits can set you back months and even years on the road to financial independence. There is a lot of debate about exactly how much it should be and where it should be kept but at the very least you want to have $1,000 saved for something unforeseen.

Fear of Investing

Too many people let the fear of investing hold them back but your bigger fear should be what would happen if you never start investing. Not everyone is going to make a fortune from their job and even fewer people are going to win the lottery.

Time is ticking and every day that you put it off, you are leaving money on the table. Get over your fear and start investing today.

Show Notes

An Mas Chili Jesus: 12% ABV, what else do you need to know?

Krane Financial Solutions: Justin’s fee only investing firm.

JKrane.com: Justin teaches business owners how to be smart with their money so they can fund personal goals.

Simple Wealth: Research and evaluate rental properties.

 

 

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