To start investing there are a few prerequisites that though deceptively simple, are absolutely essential. Unfortunately, the majority of people have trouble with these basics. But you are here because your are not the majority of people, and if you are able to put these in to practice and stick to them, you financial health will be off to a great start.
1) Spend Less Than You Earn aka Act Your Own Wage.
There is a famous line from the book David Copperfield written in 1850 by Charles Dickens that has come to be known as the Micawber Principle. It is named so after the character in the book Wilkins Micawber who gives the advice, but is himself unable to live it. Micawber advises:
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”
Understandings and applying this principle is the first key to any degree of financial stability. It is the foundation of personal financial success. If you cannot follow it, you may as well stop reading here as nothing else matters. Yes, it may not always be easy-as the character Wilkins Micawber proves (initially) by being unable to follow his own sage advice-but it is absolutely critical. Spending less than you earn consistently, over time is the only entry point to any true semblance of financial freedom. Again, it is hard, and that is because it requires self-discipline, which is never easy, even more so in our current culture in which self-discipline is little to be found while spending and rampant consumerism is advocated at every turn. Always remember, saving too much simply can’t be as harmful as saving too little.
“Spending is More Important than Income – The difference between financial happiness and misery isn’t how much you make (annual income is twenty pounds in both scenarios) but in spending less than you make. I think we can all agree that more income is better than less, but if we use our income as an excuse for not living the Micawber Principle we will likely find we cannot live it no matter how much we make. The key is to discipline ourselves to live within our means now and then widen the gap between income and spending as we make more.” –The Micawber Principle Blog
2) Develop a workable plan.
Do it thoughtfully. Write it down. Your primary job as an investor is deciding on your asset allocation. Figure this out with your age and risk tolerance. Start by gaining some basic financial literacy by reading to allow you to do this thoughtfully. Will it take some time investment? Yes. Much time investment? No.
3) Start early.
The earlier you start, the better your potential future returns will be, exponentially. Even if the amount you start with seems small, because it is invested early that small amount will have more value than larger amounts invested later.
4) Keeps costs low
Just as starting early can exponentially improve your returns, fees can reduce your gains exponentially. When you hear the words stockbrokers, brokerage firms, advisors, think one thing: “fees.” Fees are one of the few variables you can truly control, thus one must pay careful attention to the fees they are being charged and make an active and intentional effort to minimize them whenever possible.
5) Minimize Taxes (legally)
Just like reducing fees, doing this properly can result in huge savings. It is important to take note that there is a difference between tax avoidance, which is “the legal usage of the tax regime to one’s own advantage, to reduce the amount of tax that is payable by that are within the law,” and tax evasion, which refers to evading taxes through illegal means. Investing time to learn tax basics and being more tax-conscious can go a long way. For most people, some self-education and good tax software will usually suffice, although for the few with more complicated situations, a knowledgeable CPA is likely worthwhile. For investing purposes, for most it will come down to knowing which type of accounts are most appropriate for which type of assets.
6) Stay the course
You have done your reading. You have carefully scrutinized your finances, reduced your spending, and sat down and formulated a plan for yourself. You have gone through the logical reasons of why your plan makes sense for you and are convinced. The most important thing now is to stick with this plan. Most well-informed, thought out, reasonable investment plans work with minimal differences in ultimate return. Why do most people still fail at achieving their desired goals then? The problem is you. Yes you. You are your own worst enemy. Despite all the initial logic and reason that go into thinking through a plan, we are all easy prey to emotion. One has to be constantly vigilant to avoid getting side-tracked by emotion and making mistakes. You have convinced yourself that your plan works over the long term, so always be on guard to stick to it and learn to filter out all the short-term noise.
“Always remember, though many will still fall for it time and time again, there’s no such thing as a free lunch. Risk and return are inextricably related. High returns cannot be gained without losses along the way. You cannot achieve perfect safety without dooming yourself to low/negative returns. You are not trying to get lavishly rich, but rather avoiding aging poor. Remember, in the long term it is about direction, not speed. […] The promise of high returns with low risk is a reliable indicator of fraud.” -William Bernstein, The Investor’s Manifesto
Spend wisely. Educate yourself. Reign in your impulse and emotion when making financial decisions. Remember that your goal is not to became obscenely rich, but to not die poor and be able to care for your own needs as you age. Avoid scams and high fees. Invest wisely. How exactly do you going about doing this? We hope this site will help clarify that for you, even if just a little.
On a closing note, I leave you with this quote, also from Dr.Bernstein:
“Teach your children well; the most important financial bequest you make to your children will not be monetary, but rather the ability to save, invest, and spend prudently.”