9 Steps For Successful Investing - The 3rd Pillar of FIRE
Let your money do the heavy lifting by letting it grow for you.
So you’ve started saving and you’ve figured out how to make some more money too! Awesome! Now what? Time to put that extra money to work for you by investing it!
In this article, we will explore the need-to-know basics of investing and a couple of ideas on where to start!
Article Contents (Jump Links…)
Steps of a Successful Investor
Step 3 - Develop a Written Plan
Step 5 - Review Your Plan Periodically
Step 6 - Don’t Try to Time the Market
Step 7 - Ignore Market Volatility
Step 8 - Understand the Power of Compound Interest
Step 9 - Keep Realistic Expectations
Disclaimer: I am not a financial advisor, and every situation is different. It is your responsibility to understand what you are investing in.
Investing is a big topic, but many people make it way more complicated than it needs to be. It boils down to buying an asset that will either go up in value or provide a cash return of some kind. This can take the form of stocks, bonds, running a business (to sell), and more.
Key Takeaway: When you are a regular investor, you have moved on from buying things that cost you money to acquiring assets that make you money!
Some things to consider when you start
Make sure you’re ready to start investing. You should make sure you’ve done the following.
Saved 3-6 months emergency fund
Paid off all debt with over 5% interest
Made sure no other large expenses are coming in the near future
3-6 Months Emergency Fund
This step isn’t really an investment, BUT it’s the most important one. You absolutely must have an emergency fund. If you don’t, you’ll end up raiding the investment accounts every time you have a cash shortfall, and you’ll ultimately get nowhere. Get an emergency fund of 3-6 months before you even consider investing. There are some good reasons for this.
This money is for your retirement! You shouldn’t be touching this for years.
Investments go up and down in value depending on market conditions.
Life happens and unexpected expenses come up, usually at the worst time, so plan for it!
Note: Things like routine car maintenance, incidental doctor bills, or an unexpected water heater replacement are NOT emergencies. We know these things will happen. We just don’t have much control over when. You need to factor these things into your budget. Personally, I throw a couple hundred dollars into an account every month just for these types of “surprises.” It’s just a normal cost of living life. An emergency would be an unexpected job loss, a serious injury where you incur significant expense or miss considerable time at work, or a major accident that destroys a car.
Pay Off High-Interest Debt
You should pay off ALL debt except maybe your house: realistically, anything with an interest rate over 4-5%. In the short term, markets go up, down, sideways. Some years you make 10%. Some years you make 1%. Investing is a long-term game. But the average return on a well-diversified portfolio will be about 7-10%. This means any debt you have that is higher than 4-5% needs to be paid off immediately! It doesn’t matter if you make 10% in the stock markets if your credit card is charging you 18%! That’s a net loss. Car loans are a grey area for me here because rates are so low in 2021, but I’d encourage you to pay those off as well for three reasons.
You don’t want to be rolling old car loans over into a new car purchase.
You don’t want to normalize carrying a loan or buying things on credit.
It frees up more of your monthly income to invest if you don’t have loan payments.
No Other Major Expenses Coming Up
On a final note, you shouldn’t have any other significant expenses coming up in the next couple years. If you have ambitions to buy a house or go back to school, you should focus on those things first due to the uncertain returns of the market in the short term. Just keep in mind the longer you wait to start investing, the more time it will take to retire.
Investing is a process of evolution where you learn as you work toward your goals.
We all have to get started at some point! Even if you’re starting with as little as $100, you’ll need to find a brokerage firm and set up an account with them so you can buy and sell securities such as stocks, bonds, mutual funds, and ETFs. Some good companies to look at are Vanguard, Fidelity, and Charles Schwab. Two other popular options are Robinhood and Public. I recommend asking around to see what your friends and family like to use. Honestly, this is a pretty regulated industry, and they all offer similar services. Since you won’t be “day trading” or engaging in complex leveraged trading strategies, what company you select isn’t overly important. Stick to a major, well-established company that you trust, and you’ll be in good shape.
If your employer offers a 401K plan or similar tax-advantaged account, you should definitely sign up for that, especially if your employer will match what you put in. Due to the tax advantage, I encourage you to put as much as you can into these accounts. Keep in mind, this locks up your money until you are 59 ½. If you’re like me, you’ll want to access some of your retirement funds before then. That’s why you should also have an open brokerage account that you can start with one of the companies I listed above. This way, You’ll have fewer restrictions on when you can access the funds.
Hopefully, you learned this concept when saving for your emergency fund, but you should shoot to invest 10-50% or more of your income every month. You’ll remember from our Spend Less Save More post that the savings rate is the sole factor that determines when you can retire. The less you spend and more you save of your take-home pay, the sooner you’ll be able to retire. The key point here is to structure your life to reduce unnecessary expenses so you can invest as much as possible. Remember, we are trying to retire early! 10% isn’t going to make that happen. You need to be closer to the 50% range of this scale.
Pay yourself first! Once your emergency fund is built, take the money you were saving from every paycheck and put it into your investment account. By paying yourself first, you won’t miss the money or struggle not to spend the money because you never had it in the first place. It’s okay if you can only set aside $100 per month when you are just starting out. You can grow the amount over time. The key is to start developing this habit as soon as possible. If your company offers a 401K plan, I recommend you do this through a payroll deduction straight into that tax-advantaged account. You’ll save on taxes, and most companies will have some level of matching. At the bare minimum, contribute at least the amount your company will match. It’s like doubling your money instantly just for participating. If your company doesn’t offer a 401K plan, you could do this into a ROTH IRA (individual retirement account) that you can set up with the brokerage you set up in step one.
Remember:
Money in a ROTH IRA or 401K isn’t easily accessible until you are 59 ½, so if you’re planning on retiring before 59 ½, I strongly encourage you to put some of your monthly contributions into the open brokerage account.
Now that you have a place to invest and you’re in the habit of paying yourself first, it’s time to develop a plan that meets your needs and write it down. This will help you keep an eye on the prize, weather turbulence in the markets, and consistently execute on a sound strategy.
This is your life’s savings we are talking about here. Do your research and understand what you are investing in and how much you’re comfortable investing into each.
Your plan should include:
Your goal amount for your investment portfolio
What % you want to have invested into different assets
When you want to retire by
How much you plan to invest every month
Diversification is key.
You’ve probably heard the saying, “Don’t put all your eggs in one basket.” It’s often tempting to put all of your investments into something you are familiar with, such as stocks of the company you work for. The problem is if something goes wrong, you get burned. Make sure to diversify your investments into multiple market sectors and asset classes. This includes investing in index funds holding the stocks of many companies (I personally like VTI, which invests in all publicly traded US companies.), but can also include other assets such as bonds, real estate, a small business, and more. I’ll do future articles on this, but to keep this from turning into a book, we will stay focused on the framework of a successful investor.
You might be trying to maintain a mix of investments, such as 10% bonds/80% total market fund/ 10% tech stocks. As time passes, the sectors will perform differently, and you’ll need to sell and buy to maintain your target balance. I try to do this about once per year. This is enough to keep things on track, but not so frequent that it becomes another job. If you want a truly set it and forget it option, you can buy into a target-date fund provided by your brokerage. Another option is to do what some more aggressive investors do and just buy a total market fund such as VTI and trust the markets to do their thing. (Think of it as a rising tide lifts all boats.)
This yearly review is a good opportunity to evaluate if you are on track to retire by your goal date or if you need to increase monthly contributions to stay on track.
Stay invested, and don’t try to time the market. This is something I could’ve done better when I was starting out. It’s tempting to sit on cash when big events happen, hoping to “buy the dip,” such as presidential elections, planned legislation, etc. These often turn into missed opportunities. If you had just been fully invested per your written plan, you’d probably have done better.
Remember:
Time in the market beats timing the market.
Sometimes it’s a bumpy ride.
It’s easy to let your emotions get the best of you when the stock market goes through a period of down times. You worked hard for your money. I know how it feels to watch the number shrink. Just remember it gets easier as the investments start to work for you and you see the power of compound interest. If you panic sell when the value of your portfolio dips from time to time (which is normal!), you’ll be “buying high and selling low,” which isn’t a winning strategy.
I could write an entire article just on this topic! Compounding interest is an amazingly powerful tool. Essentially, as you make more money, the money you made gets reinvested and makes you even more money. It’s like a giant snowball rolling down a big hill. It starts small, but with a good push, it’ll be far bigger than you can imagine by the time it gets to the bottom.
The future is bright, but keep perspective.
While investing is a great way to retire early, it takes planning and discipline. These traits are especially important early in your investing career. Consistency is key. While we’d all like to get rich overnight, you need to keep in mind that investing is a game played over time. You have to plant the seeds and let them grow. Avoid the FOMO (Fear Of Missing Out) effect. Inevitably, you will have friends and family tell you about the hottest new thing: GME, cryptocurrency, etc. It changes every few days. It can be hard to stick to the plan.
This isn’t investing: it’s gambling. Your chances of retiring early are about as good as hitting the jackpot in the casino, maybe even worse than that with these risky, speculative bets. Don’t do it! Stay the course. Slow and steady will win the race! If you struggle with FOMO, I strongly encourage you to read the book Fooled by Randomness. It’s a great look into survivorship bias and why it’s so dangerous!
The best time to plant a tree was 30 years ago. The next best time is today. It’s the same with investing. Start today, pay yourself first, and resist the temptation to withdraw from your FIRE account.
As you start to see this account grow, the temptation to buy things may grow. Remember, this money is being set aside for a reason. Don’t take detours to buy the shiny new car or second home. It’ll look much more affordable when you have a few hundred grand sitting in the bank, but these detours will postpone your retirement significantly! Once you have a sizable account, that is when you need to let the power of compounding returns take hold and finish the race for you. Your money can’t work for you if you keep spending it on stuff you don’t really need.
I could write a full article (or in some cases a book) on each of these topics, but I wanted to keep this all in one framework post so you could see the big picture of putting your money to work. It’s easy to get lost in the weeds and lose sight of the big picture of what investing is all about. That is what this post was all about. If you want to see how I’m managing my investments, below is a list of my monthly updates so you can see how I’m personally putting these concepts into action.
If you’re interested in what I’m doing with my investment portfolio, check out my monthly update series where I go in-depth with what I’m currently doing, what’s working, and what I’m doing differently moving forward.
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