Knowing how to invest and choosing appropriate investment strategies are a crucial part of any personal financial plan, but there are some things that should probably take priority.
1. Get rid of high interest debt
It generally doesn’t make sense to start investing if you are paying high interest on debt since even the best investment strategies aren’t likely to make anywhere near that return (over the long run) on your investments.
2. Build an emergency fund
Everyone should have an emergency fund in case of an emergency.
3. Create an estate plan and obtain insurance
If tragedy were to strike in the near future, having a solid estate plan in place and being properly insured will likely be much more beneficial than any investment earnings you may have earned. Appropriate insurance may include:
- Life insurance
- Homeowner’s insurance
- Auto insurance
- Health insurance
- Disability insurance
- Personal liability insurance
- Long term care insurance
4. Pay yourself first
Try and save at least 15 – 20% of your annual income. Knowing how to invest is important, but solid investment strategies won’t get you very far if you have no money to invest. Creating a budget can help you figure out how much of each pay check you can afford to save and invest.
If you can’t save that much, save as much as you can. Reducing your expenses or increasing your income can help you save more. Consider setting up automatic transfers to your brokerage account or IRA.
5. Create an investment plan and stick to it
An investment plan should list out your investment goals, investment strategies, and how you are going to achieve them.
It might contain how much money you would like to have when you retire at a specific age, how much you need to invest each month to achieve that, which IRA or brokerage account you will use, how those funds will be invested, and how you will evaluate your investment performance. Create an appropriate investment plan and stick to it.
How to Invest & Basic Investment Strategies
It can be very overwhelming for a beginning investor to know how to invest or to know what investment strategies to use.
- Should I put my money in stocks or bonds?
- Should I purchase individual stocks or mutual funds?
- Should I invest $5,000 in Apple stock because it has performed incredibly well in the past?
- Should I listen to the guy on TV who expects a certain stock to shoot through the roof?
I explain below the basics of how to invest. I also explain my own personal investment strategies in case they help anyone. Warning: my investment strategies are not sexy. However, they are based on solid research and help me sleep well at night. Best of all, my investment strategies take very little time and are very easy so anyone can do them.
However, keep in mind that there is no one size fits all. What works for one person may not be right for another person. If you want assistance, seek out a qualified advisor who can review your personal situation and provide specific advice on how to invest.
Basics of How to Invest
Learning how to invest is not rocket science. In fact, it only involves a few simple steps.
1. Open up an appropriate brokerage and/or retirement account
The securities and mutual funds you purchase will be held in these accounts.
Personally, I first invest enough money in my 401(k) to max out my employer contribution. I then invest in other tax advantaged accounts, such as IRAs. If I have additional assets to invest, I then invest them in a general brokerage account.
I personally prefer discount brokers such as those listed above because of the low fees they charge.
2. Choose an appropriate asset allocation and stick with it.
Studies have shown that a very high percentage of a portfolio’s performance is determined by asset allocation, rather than market timing or security selection.
Your asset allocation should depend on factors such as your risk tolerance, age or time until the funds are needed, personal circumstances, and your goals. Once you find an appropriate asset allocation, stick with it no matter what the market does.
Many people choose an asset allocation but then go to cash after the market crashes and buy back in after it goes up. This is a formula for buying high and selling low and incurring unnecessary taxes and fees. Don’t do this! Most professionals can’t time the market with any degree of accuracy and you probably can’t either. I know I can’t.
Some experts suggest the following rule of thumb: subtract your age from 100 to compute the portion of your portfolio that should be invested in stocks, with the rest being invested in other assets such as bonds and cash.
Investing in a number of different asset classes and securities can help you diversify away part of the risk in your portfolio.
3. Choose appropriate mutual funds and/or securities
I personally prefer mutual funds over individual securities since they provide instant diversification and professional management.
As a passive investor, I generally invest in high quality, low cost index funds and ETFs that try and mirror the market rather than try and beat it.
I use a buy and hold strategy that involves very little trading, no market timing, no chasing winners, no day trading, no listening to “experts” on TV, and no selling when the market crashes, which keeps things simple and keeps my transaction costs and taxes low.
Research has shown that most passive investors tend to achieve higher returns in the long run than most active investors after considering taxes and fees. In any given year, a number of actively managed funds will beat the market, but it is difficult to do this over the long run.
Investing the same amount automatically each month into the same mutual funds (aka “dollar cost averaging”) ensures that I am still buying when stocks are cheap, or buying low, which many people have a hard time doing.
4. Rebalance your portfolio from time to time and monitor your portfolio
Rebalancing is simply a fancy word for adjusting your portfolio back to your target asset allocation percentages (i.e. selling some of your winners and investing the proceeds into your losers). I personally do this about once a year. Rebalancing helps you buy low and sell high.
5. Adjust your asset allocation as appropriate over time
As you get closer to needing your money, you will likely want to decrease your exposure to stocks and other risky assets and increase your exposure to less risky assets such as bonds and cash. This is because the closer you are to your goal, the less time your portfolio has to recover from downturns in the market.
Using a Financial Advisor
If you don’t feel comfortable investing on your own, then seek out the help of a qualified financial advisor who can help you invest appropriately given your personal situation, goals, and other important factors.
Additional Reading on How to Invest & Basic Investment Strategies
If you want to learn more about how to invest and basic investment strategies, you might read the following books:
- The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books. Big Profits)
- A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing
- Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies
- The Bogleheads’ Guide to Investing
- The Random Walk Guide To Investing
I mention a number of great personal finance books on my blog. However, these books on how to invest are hands down some of the best and most useful in my opinion. If you were to only read (or give away as gifts) a few of them, please strongly consider these books on how to invest.
Many people have no idea how to invest, don’t understand basic investment strategies, and end up accidentally doing all of the things they shouldn’t do. Don’t be one of those people.
What are your thoughts on how to invest? What investment strategies do you use? Leave a comment below!