A beginner’s guide to investing your money
Personal finance is almost a dirty word. People squirm when asked about it and generally try to avoid talking about it.
There are no subjects in school that focus on managing personal wealth, and even the most highly educated graduates often shy away from the topic. Instead, we are bombarded on a daily basis with ads and Instagram posts luring you to spend your savings on the next shiny new thing. No wonder debt is such a persistent vicious cycle in this time and age.
Due to the lack of general knowledge and interest in personal finance, most people prefer to outsource it entirely. For decades, bankers, traders and financial advisors have made a roaring trade of managing personal funds and siphoning away a large percentage as fees. You are often told to ‘leave it to the professionals’. To make things worse, these so called professionals often convince you to take up a variety of investment opportunities not because they benefit you the most, but largely because they pay the highest sales commissions.
I have personally encountered such people - so-called certified financial advisors, who ended up convincing their aging relatives or young friends to make sub-optimal investment decisions, just so they could hit their sales goals.
The concept of personal finance has thus become convoluted and fraught with danger. You can’t even trust your own financial advisor. Procrastination is therefore an easy reaction to this topic. It often takes months and even years to come up with a well thought out plan for any excess cash you have lying in the bank.
However, if you are reading this article, I assume you have found some sort of financial awakening which is propelling you to improve your personal finance situation. Congrats, you are already ahead of the crowd, you just need to take actual steps to move the building blocks into the right place.
Everyone needs to learn about the basics of personal finance, at least as well as knowing which characters in Game of Thrones belong to which houses. If not, you are seriously doing yourself a disadvantage in the game of life.
Let’s jump right into it.
There are 3 main asset classes, you need to know about here:
The TLDR here is to spread your money among these 3 categories according to your age and risk profile.
As you can see, the higher the risk, the higher the return. Generally, you should hold more equities when you are younger and have a higher risk tolerance, because you allow for significant upside if the stock markets do well. The priority in this phase is growth and allowing your returns to compound over time. More on the magic of compounding later.
As you move closer to retirement age, you should start to move more of your investments into bonds and pare down your overall percentage invested in equities. In addition, there should be much less need to take unnecessary risks once you are close to your retirement sum. The priority in this stage of life should be capital protection and receiving stable returns.
To quote an example from financialsamurai.com,
A 40% weighting in stocks and a 60% weighing in bonds has provided an average annual return of 7.8%, with the worst year -18.4%.
A 50% weighting in stocks and a 50% weighing in bonds has provided an average annual return of 8.3%, with the worst year -22.3%.
For most retirees, allocating at most 60% of their funds in stocks is a good limit to consider. An average annual return of 8.7% is about 4X the rate of inflation and 3X the risk free rate of return.
Now that you understand the basics, how should you go about investing your money?
Some of these methods do the entire shebang for you by allocating your money among equities, bonds and cash, and some of them only focuses on equities. It is unlikely that you will be able to put all your eggs in a single account if you want to maximise other perks like tax savings or account bonuses. However, through the use of tools like Personal Capital, you should be able to comfortably monitor and manage a few accounts to maintain your ideal portfolio mix.
Here are the key accounts you should have:
Pension fund account e.g. 401k
As long as you are not in credit card debt, you should always aim to max out your yearly contributions to your 401k (or any pension fund depending on your country). This is often the most tax efficient instrument you have in your investment arsenal. Why pay taxes when you can keep the money for yourself?
Once you get the cash deposited into the pension fund, invest in stocks or bonds using the pension funds. Many in the FIRE community swear by Vanguard funds in particular putting most if not all of your 401k into the VTSAX.
The TLDR of this method is that most individual (and even professional) investors suck at picking stocks, so buying a fund which mirrors the entire index is actually the most profitable bet in the long run. It doesn’t hurt that the management fees (0.04%) are super low which matters when you want your savings to compound as quickly as possible instead of lining the pockets of a fund manager.
2. Direct investment platforms
Once you start hitting the maximum yearly contributions to your pension funds, you will find that you still need to invest your excess savings elsewhere to grow your money pot. If you would like to pick your own stocks and bonds, you can purchase them directly through various trading platforms.
Remember that time in the market beats timing the market, so unless you are an expert, its ill-advised to try to day trade or predict market trends. If you choose to buy/sell a lot of equities, remember to use a no fees trading platform like Robinhood.
Personally, I hold a few stocks with high dividends and invest a little in high growth tech stocks. I tend to only invest if I am sure I can hold the stocks for more than 5 years and I understand the core business trajectory of the company. Having experienced a very volatile stock market in 2009, I make sure I have stop loss safeguards set for all of them so that I don't get caught off guard in a sudden market downturn.
3. Robo advisors
Tech is eating everyone’s cake nowadays, even that of financial advisors. Firms like Betterment, Wealthfront and Schwab can now help you allocate your savings automatically each month. Most of them sound pretty good and have low fees. I spoke to a few of them but I do not use any of them as they do not handle overseas investments. Given that they are a relatively new channel, I think its going to take some time before they are proven to be a good way to invest.
4. High savings rate accounts for your cash
You need cash for day to day expenses, and deal with sudden expenses like a car repair or minor operation. As a general rule of thumb, most people advise keeping three to six months worth of living expenses in liquid cash.
Frankly, I do not like to keep too much in cash because I am always trying to make my money work hard. Currently I have about three months in cash and another two months in highly liquid bonds which I can cash out anytime without a loss. Even for the three months of cash I hold, I maximise the return by keeping it in a high savings rate account.
Even though it’s usually cited as a joke, I seriously believe that there are still plenty of people who stash their money under their pillows (or just at home in a secret copper tin) due to a general lack of trust in financial institutions. If you can overcome that paranoia, I advise you to shop around for savings accounts with the highest interest rates, and be prepared to re-evaluate and move your money around banks from time to time.
My current favourite is the Alliant credit union savings account which provide me with 2.1% APR, no monthly service fees, or minimum balances. I also deposited $15,000 in a Citibank recently to take advantage of a $500 account opening bonus.
There, if you made it to the end of this article, I hope this has been a good segue into the basics of investing your money without overwhelming anyone with too much jargon. Let me know if any of the above recommendations have worked for you, and if you have any other financial tips for beginners.