Years before my wife and I were married I had started investing in stocks and mutual funds. The main problem was that I didn’t have a written financial plan. It was hit or miss although I did get into a 401(K) while working that helped toward my retirement when the companies I worked for didn’t offer pensions any longer.
Here at AskingDad.com we want you to learn from our mistakes and give you something to consider before you start investing. This plan is for someone that has developed a budget and has money left over in which to invest. If you have already started investing you can compare your plan to ours and maybe incorporate some of these ideas. Here are the main steps we recommend:
- Write up a financial plan based on realistic goals
- Start saving and investing based on that written plan
- Reduce risk by diversification
- Buy low-cost index funds (or Exchange Traded Funds)
- Rebalance at least once per year
Let’s go into more depth on each step.
Step 1. Write up a financial plan based on realistic goals
Once married, my wife and I would spend four hours in a library conference room, in an empty room at church, or a place where we could discuss our goals. We would discuss our Family, Financial, Fitness, Self-improvement, Social, Spiritual, and Career goals. We wrote down our one, three, and 10-year financial goals. We would not overload each year and would discuss what we felt we could accomplish in those time periods. Here’s an example:
Financial Goals
1-year
- Save for a vacation to Gatlinburg, TN
- Replace Dodge vehicle
- Purchase furniture for the living room
- Paint outside of the home
- Redo landscaping
- Increase 401(K) amount from 8% to 9%
3-year
- Purchase bedroom furniture – dressers, side tables, lamps
- Save for vacation to Walt Disney World
- Save for a fence around the back of the home
- Paint and carpet first floor
- Finish off basement with carpet, ceiling, and storage area
- Increase 401(K) amount to 9% to 10%
10-year
- Replace Buick with Toyota van
- Set up children’s college accounts
- Complete furnishing Dining Room and Living Room
- Purchase sewing machine
- Get a family account at local pool and workout facility
- Revisit percent increase for 401(K)
We made some of these goals and those that we did not – we adjusted them. Having written goals is important. “A goal is a dream with a timeframe on it.” We would do this every year and make changes as our life circumstances occurred.
Step 2. Start saving and investing based on that written plan
Knowing what was important to both of us gave us confidence. Both of us had jobs and had some money socked away. My father was a spender and my mom was a saver. I chose to save and invest based on the written plans we put in place. I took a page out of my dad’s playbook and starting investing in dividend stocks because you could normally count on when each would pay a dividend. This helped meet some of these needs. In the back of my mind, it was important to invest my retirement money for the long-term and I chose funds that had lower fees. The key thing was to get started.
Step 3. Reduce risk by diversification
Some people chase the “hot” stocks, the so-called FAANG stocks – Facebook, Amazon, Apple, Netflix, and Google. They have done well but they have been very volatile. Instead, I prefer spreading my investments around. I don’t chase past performance and recognize that it’s important to have various asset classes in my portfolio.
One rule I have used was taking 110 and subtracting off your age. Let’s say you were 30. That means that you would take 110-30 = 80. This means that 80 percent of your investments should be in stocks, mutual funds, exchange-traded funds (ETFs) or the like and about 20 percent in bonds or savings accounts. Within the stock portion of your portfolio, it would be good to have a percentage of large-capitalization U.S. stocks, small capitalization U.S. stocks, or international stocks. The bond portion can be made of high-yield bond funds, T-bills, or even money-market funds.
You must know what your risk level is before you put 80 percent of your hard-earned cash into stocks. The market goes up and down and if you don’t like that volatility, you’ll have to reduce the stock portion and increase your bond portion in order to reduce volatility.
Step 4. Buy low-cost index funds (or Exchange Traded Funds)
Burton Malkiel wrote a book called the Elements of Investing. It is an excellent investing book that I have bought several copies and given them to my sons to read.
One of the key tenets of that book is to buy low-cost index funds. Index funds are based on a specific index. These funds do not have a fund manager (or investment teams) making the buy and sell decisions on a daily basis – it is passive and the fees are much lower than an actively traded fund.
This is why Mr. Malkiel wrote the book to encourage investors to be able to get diversification within an index fund and still have low fees. As mentioned before, financial markets are uncertain, but fees are certain. Consider Vanguard and Fidelity and other well-known mutual fund companies before you chase the latest high profile fund that eventually will underperform the market for several years.
Step 5. Rebalance at least once per year
This can be tough to do, that’s why I recommend doing this about once per year. If you follow step 3 to decide what your risk tolerance is, then you have a plan on rebalancing. For instance, if you start the year with 80 percent stocks and 20 percent bonds and over the year your stocks have increased so when you calculate the ratio again it is now 90 percent stocks and 10 percent bonds, you need to make an adjustment to get back to your 80/20 ratio. The reason for this is that it puts you in a situation where you could incur more losses if the market turns down.
To get back to your ratio, you would have to sell some of your stock funds and buy some of your bonds funds to get to your 80:20 ratio. This rather simple move will help you sleep better at night knowing that your tolerance for risk has been mitigated.
Somewhere along the line, I’ll have to put in a quiz to help you decide how you can determine your risk level.
There you have it. I could go on discussing dollar-cost averaging, minimizing taxes, growth vs. value stocks, etc., however, those would be secondary to get you started. One of the mantra’s I use is the KISS principle – “Keep It Simple, Sweetheart.” One of the things that you’ll hear me write and say is that if you don’t understand it, don’t invest in it. You can get into a lot of trouble and become very discouraged by letting someone talk you into something because of the latest fad or investment “opportunity.”
Quote for the Day: “Make no small plans, they have no magic to stir men’s souls.” – Daniel Burnam
