The other day I heard someone compare investing to losing weight quick strategies. I thought this was interesting and very true, because there are new diets popping up every day promising the best results in the least amount of time. It’s the same with investing. There is always a new fund or strategy that promise amazing results with minimum effort. The problem with this is that these things don’t work. Sure, those diets might work for a period of time, but more often than not people either give up because they are too unrealistic, or they put on all the weight back again.
There is no amazing results with minimal effort in investing. The best way to build wealth is really through persistence and discipline. Just like dieting, it’s making good choices day after day, slowly adding up your results. Sometimes you might slip, but not all is lost and you can get back into it. Results take time and I’m afraid there is no secret to getting quick results. This is a much healthier approach that putting 100% of your efforts in the hopes of a quick win, and then get frustrated, tired, lose money and realise that “investing is just not for me”.
My approach is one of slow and steady, one with the long term in mind. And here I share 4 steps to help start investing right from the beginning.
Know where you stand financially
This may sound like a cliche, but it is crucial before you start investing. You must know where you stand financially. You must know your income, expenses and commitments. And from there you can define your priorities.
Do you have debt? There is not much point in allocating money to be invested if you are paying high interest rates on your credit card. Design a plan to pay off high interest debt as quickly as possible. Negotiate other long-term debt. Know exactly how much you own and how much money you need to allocate towards paying off debt each month. Personally, I believe that consumer debt is like an emergency. You are leaking money and need to stop it as soon as possible. Sure, there is long term debt that can be necessary or even desirable, like a home loan, but most of it should be avoided and if not possible paid for quickly. Once you have a good understanding of where you stand financially you can move to step 2.
Build an emergency fund
In order to start investing the right way, you must have an emergency fund. Now that you know where you stand financially, you also know how much your expenses are. Your emergency fund could be anywhere from 3 to 12 months of expenses. It is up to you to decide how many months is right for you. When deciding, take into account how secure your job is, your field of work, how long you realistically would need to get another job if need be, your personal commitments, etc. If you’re a single mum, for example, who is solely responsible for paying all the bills in your household, having a larger emergency fund can give you more peace of mind.
I personally like to have 6 months of expenses in my emergency fund, and I keep this money in a high yielding savings account (even though interests are very low at the moment). I feel that this is a good amount for me, it gives me peace of mind, while not being too large that I would feel like I’m wasting the opportunity to have better returns. It is a good balance that works for me.
If you are just starting out, don’t be discouraged when starting to build your emergency fund. It can take some time, maybe months, especially when you don’t have a buffer and everything seems like an emergency. Just keep saving, keep building your fund. Remember that persistence and discipline are key to investing.
Define your asset allocation
Once you have your emergency fund and good control of where your money is going, you can start to allocate funds towards investing. Before you buy into any funds, I suggest you have a good think about your short and long term goals. Think about what you want to achieve with your investments. I strongly suggest that everyone should be investing to achieve financial freedom (when you can live off investment income and no longer need a job), but you might have other goals as well. Then make sure to read this post about defining your asset allocation.
When defining your asset allocation, take into account your risk profile, how much time you want to spend managing your investments, what sort of diversification you think would be right for you.
Personally, I like to invest the bulk of my net worth in index funds. They are an effective and low cost way to invest in the stock market. I diversify by investing in different types of index funds and in different locations in the world. You need to come up with a strategy that is comfortable for you. I do advise though, regardless of how you choose to invest, that you check thoroughly how much you are paying in fees. As we are investing for the long term paying high fees can have a huge impact on your returns, net worth and on how soon you achieve financial freedom.
Slow and Steady
Now you know your numbers, you have your emergency fund and you know your asset allocation. Now all you need to do is be disciplined and persistent. There will be times when you will be tempted to use your emergency fund for something that is not really an emergency. Resist the urge. Remember that it is there for peace of mind in case of an emergency. There will be times when you won’t be able to save as much of your pay check as your normally do. Don’t get discouraged. Make up for it next month. Just keep going. Remember that what will make the most difference in achieving your life goals is what you do consistently, and not the one-offs. Life is real and messy, and adjusting is part of what we need to do to stay the course.
What about you? What step are you working on right now? Would love to read more in the comments 🙂