Most younger people know they should be investing once they graduate from school and enter the real world, but have know idea where or how to start besides calling mom and dad and asking them how to invest. Sorry to say, but unless mom and dad have done well for themselves, retired early or are fairly loaded and own their own businesses, they probably are not the right people to ask - which is why you came here to my website. If you are starting from scratch, or not, below you will find some of my basic rules for investing.
One of the first questions most people ask once they enter the real world and get a big boy or big girl job is how much of their money should they invest. The general rule of thumb is you should start out by investing at least 10% of your take-home-pay. This old wives tale might be a decent place to start, but the real answer is to invest as much money as you possibly can if you want to retire before the age of 65. More likely than not, each individual will need between $1 million to $1.5 million to retire early, depending on spending habits and depending on what age you plan to retire. The 4% rule is a great place to start to set an approximate target for necessary money needed prior to retirement.
The next question to ask is where to invest your money. The first place to start is to find out if your workplace has a 401K match. There isn’t much in life you can get for free, but an employer match on your 401K investment is just about the best you can expect. At my own company, my maximum match is a 5% investment from my own salary and another 4% matched by my employer. Don’t try to get fancy with your 401K investments, put it straight into an S&P 500 index fund with low rates like SPY or Vanguard’s S&P fund. Try to max your 401K out to your employer match (not the full amount) before shifting to your next investment, your own savings account!
There are two standard rules of thumb in regards to savings accounts. Save up $10,000 and save up 3 months pay in the case of an emergency. I recommend starting with a nice $3,000 to $5,000 in savings if you are renting, more if you own a house and then just continually put $100 per month away in the event of an emergency. A helpful hint, don’t just use your bank’s standard savings account, but find an online savings account with a better return to at least match inflation.
After you have started investing in your 401K and have a decent savings as suggested above, my next recommendation is to max out your Roth IRA ($6,000 in 2019 per individual). What is a Roth IRA? It’s an individual retirement account that allows you to accumulate capital gains tax free with after tax money. If you are young, it’s the first place you should start investing if your employer doesn’t provide a 401K match. Again, no need to get cute with your Roth IRA. I have mine on Etrade and simply invest in index funds and also a few choice long-term growth stocks like Amazon, Google and Apple, which have treated me well since I started.
If you still have money to invest after you have maxed out your 401K match, have saved your 3 months pay emergency savings and have maxed out your Roth IRA, then you will have a few different options to consider based on your risk tolerance. When it comes to risk tolerance the further away you are from retirement (young) means you should chance some riskier plays with investing (risky, not stupid) and the closer you are to retirement (old) means you should select some safer choices, like high yield dividend stocks, index funds and real estate. One of the most important rules of investing though (often stated by Jim Cramer on “Mad Money”) is that the only free lunch in investing is diversification. You need to diversify your investments.
Now when it comes to diversifying, it’s not just about diversifying your stock choices or fund choices, but also diversifying your asset classes in your portfolio. To provide an example, I have a luxury short term rental house, index funds, stocks and cash at the moment. The way they are currently split (as of May 2019) is 40% of my funds are in my one piece of real estate, 25% are in index funds (dispersed between my 401K, my Roth IRA and a non-retirement account Vanguard index fund), 21% of my money is in individual stocks (via my Roth IRA and a Robinhood account) and 14% of my money is in cash in various savings and checking accounts.
Most financial advisors (whom are more sales personnel than financial experts) would hate the high percentage of my portfolio in stocks and the fact 40% of my funds are tied up into one investment. However, I’m young (31-years-old) and still making my way with a lot of room for risk. Benjamin Graham, the author of the renowned “Intelligent Investor” says to cap any investment at 10% as a percentage of your portfolio. Therefore my real estate investment would be considered high risk. Jim Cramer from “Mad Money” often states to only have a max of 10% of your portfolio in individual stocks or “Mad Money” and to have the rest in safer investments like index funds. Counter to this advice the experts at The Motley Fool often advise that if you do your homework and pick the right stocks, you can beat the average return of the S&P 500, which is risky and does take a good amount of your time as the investor, but they have consistently been proven correct with their own stock choices. I do put a decent amount of research into my investing on a weekly basis, therefore my investing of 21% of my portfolio in individual stocks leaves me in a comfortable position.
Now, another question might be how do you diversify your stocks? How many individual stocks should you own? How many from each sector? What is a sector?
The Motley Fool often suggests having one stock based on your age. So if you are 22-years-old, you should have a 22 stock portfolio. If you are 59-years-old, you should have a 59 stock portfolio. The goal is having so many individual stocks will spread out your risk. Contrary to this more intensive theory, Jim Cramer often states to have no more than 10 individual stocks in your “mad money” portfolio along with other more diversified investments like an S&P 500 index fund. With only a 10 stock portfolio, you have a more focused portfolio in which you can actually research, follow and know all 10 of your stocks. Somewhere in between Benjamin Graham in the “Intelligent Investor” mentions not having more than 10% of your portfolio in any one stock, but also not spreading yourself too thin. If you own too many individual stocks, what’s the point of owning individual stocks in the first place? You might as well just be index funds or mutual funds. From my perspective, the best place to be is somewhere in between. Perhaps 10 - 20 stocks, which you can follow and also keep below 10% of your portfolio.
I do like to diversify stocks from different sectors and when I purchase individual stocks its a bonus to get stocks that are not isolated on one sector or one market, but hit multiple markets. One example is Boeing (BA). Boeing is not just an aerospace stock, but also hits the industrials sector and the defense sector. Another example is Google (GOOG). Google is generally considered a tech stock, but they also generate a lot of revenue from advertising, web services, hardware and are getting into the self-driving vehicle business with Waymo.
One question that often pops up for me is what to do if a stock booms or grows and surpasses the 10% mark on your portfolio. Do you sell? My strategy is to never sell winners, but keep riding them out. I like to buy and hold stocks for the long-term, not trade day-to-day. If a stock booms (like Amazon did for me when it shot from the $800s to nearly $2,000 per share), then I hold on and just buy other stocks I like to dilute the percentage of my portfolio in the big winners.
What about bonds? I’m anti-bond and for defensive or safe alternatives, I would choose high yielding dividend stocks or passive real estate investments. Bonds (especially this day in age) barely yield above inflation. There are better safe investment alternatives out there to bonds.
What’s wrong with mutual funds? Historically most index funds perform better than mutual funds and have lower service fees, which saves you a ton of money over the long run. There are many index funds or ETFs out there in most 401K or IRA accounts. I prefer Vanguard’s funds as they have lower fees than anyone.
Should you invest in stocks or real estate? I say both. Real estate investments are great and can bring back multiple forms of income, plus have amazing tax advantages. Real Estate investments require more capital up front and are much less liquid than stocks, meaning they are more difficult to transition from investment to cash if necessary. Building wealth through real estate is generally less passive than through stocks, requiring more time and effort, especially up front. If you plan to invest in real estate, you need to act as if you are starting your own business. I personally invest in stocks and real estate, but recommend starting by building a small stock portfolio and once you are confident in your analytical and investing skills and have built up a decent amount of wealth, it is worth considering transitioning into real estate investing.
Robert Kiyosaki of “Rich Dad, Poor Dad” fame will often remind you, your personal home is not an asset and is not an investment. Not unless you are househacking or bringing in income due to your ownership of the property. One great thing about investing in real estate is the instant diversification, every property is different. In most cases the more doors (units) have on each property is ideal to bring in more income. Househacking with a triplex or quadplex is a great place to start. Or even buying a college house and renting out to your friends if you can convince your parents! There are a ton of ways to invest in real estate from residential, to commercial, to land and you can get very creative with structuring deals, which makes it an ideal way to make money using other people’s money, by financing the property at a lower rate than the money you have coming in from the property.
Perhaps the best way to invest is to invest in yourself by starting or owning a business. Owning a business is another great way to find tax advantages, besides having the ability to control your investment. Control is the name of the game and if you can create, own and structure a successful business - you have much more control than simply buying stocks or pieces of other businesses you don’t control. As stated above, getting involved in real estate investing should be considered a business in itself.
There are plenty of ways to invest, but this is just a basic breakdown. For more advanced investing tips, please check back on my website! Feel free to comment or email me anytime for advice!
SOURCES:
https://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/