Investing for Financial Independence
Here’s part one on investing for financial independence. For those of us working towards financial independence investing is not an option, it is mandatory. I’m an avid investor and have been investing in various types of market securities for over 30 years. I’ve had mixed results but overall am happy with where I’m at in my investments and how they’ve performed.
Investing may be challenging to some that do not have a background in finance or the markets. Making investment decisions can not only be challenging, but intimidating as well. Luckily there are a wide range of investment options available For everyone. The wide range of available investment possibilities also make investing puzzling to many. This can lead to confusion and frustration. Worse than that is the possibility of market losses because of a bad investment decision. I hope that with the information you’ll find on this site you’ll become a more knowledgeable investor and avoid the pitfalls.
To that end I’ve split up the Investment primer into two sections. The first, preparing to invest, will give you some insight into your investment style. Factors such as your risk tolerance, age and goals are important considerations in determining what type of investor you should be. The second section is an introduction to just some of the investments that are available to you. Both of these areas warrant more attention than can be given on one or two posts. Expect to see a lot more on these topics in future posts.
Do you know what your investment goals are? Are you facing retirement in five years or do you have 30 years of career ahead of you before you have to worry about retirement? How do you handle risk? Do you cringe at the thought of losing a few dollars or are you the “damn the torpedoes, full speed ahead” type? These are all important questions in determining what kind of investor you are. I’ll explore some of these a little further here in this post and in more detail in later posts.
Knowing and understanding your tolerance for risk should guide you in how and where you invest your money. Investment risk tolerance is a complex but important topic. Luckily there are free resources available on the Internet to help you assess your own risk tolerance. If you search for “Investment Risk Tolerance”, you’ll find a number of quizzes and calculators that can help you with this. I myself lend heavily towards being an aggressive investor. It’s led to some significant gains as well as losses over the years. Being consistent with this style has resulted in being able to beat the markets by a slight edge over the years. I’ll warn you that aggressive investment is not for everyone though. If a 20% drop in your portfolio leads you into a panic sell, then stay away from the more volatile investments.
Part of your investing strategy should be deciding what the balance of securities you’ll have in your portfolio. What percentage of your portfolio will be in stocks, vs bonds vs fixed income? You should set a target percentage for each of the categories of securities you’ll be invested in. Your risk tolerance will play a large part in this decision. As will several other factors such as goals and age.
Your age is important in establishing what balance of securities your portfolios are invested in. Typically the younger you are, the more aggressive you can be in your investing. A good rule of thumb is 100 minus your age equals the percentage of your portfolio that should be invested in stocks. Lately, many financial advisers have changed this to 110-120 minus your age to account for longer life spans. These rules may not apply to everyone, short term goals should guide you in this as well. For example, if your portfolio will be funding a house purchase within a few years then you may want to keep less in stocks than the formula would say to.
The next thing to think about is where to keep your investments. The bulk of my investments reside in either a 401k or an IRA. There are two important reasons for this. First, gains from your investments are sheltered from taxable gains. Second, your funds are sheltered to some extent from creditors and bankruptcy. WARNING, Check with a professional adviser on this point, laws change from year to year and vary state by state! 401k’s are more restrictive in what you can invest in. An IRA gives you a much broader choice of where you can invest your money in. The other option is a”street” account. Which is basically an account where you have access to various financial investments, including futures and options, which you typically cannot trade in a retirement account.
How much can I afford to invest? How can you afford not too?! This can be a challenge to those of us that are paying off our debt. But savings should be as important a part of your budget as paying off debt. Debt should be prioritized and paid but there should be some set aside for emergency funds and for long term savings. This really comes down to creating a realistic budget within your means. If you feel like you have too little to invest, please don’t allow that to hold you back. Even if you have limited funds there are online brokerages, such as Motif Investing, that allow you to start investing with as little as $250 – or in some cases less.
At the very least you should have some funds withheld in an employer sponsored 401k at work. Having these funds withheld from your pay check is convenient. You never miss or are tempted to spend what you never see in the first place. One other HUGE consideration is your employers matching contribution, that’s an instant return on your money! depending on how your 401k plan is structured, that can be as much as a 50% instant return. One last thought about 401k’s, every dollar you contribute means an instant federal and State income tax savings. The amount you contribute reduces your taxable income. Every dollar you put in will cost you less than a dollar out of your paycheck!
The last thing I’ll talk about in this post is your investing goals. Understanding what your goals are in terms of investing is critical in guiding you in what you invest in. It’s not so much what you plan on doing with your money but when you will need it. if you’ll need the money you plan on investing with in a few years then stocks and other riskier investment vehicles are not where you want to put your money. Less risky income oriented investments would be more suitable. If however you won’t need that money for a longer term then investment vehicles that are riskier but have a higher rate of return are more suitable for you.
Coming soon will be part two of Investing Introduction where I’ll cover some of the more common investment types that may have a place in your portfolio.
Part two of investing for financial independence can be found here: Investing for Financial Independence – Part Two
Image Credit: Svilen
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