People exist on three different strata on the financial and economic ladder. The people on the lowest rung of the ladder are the Spenders who earn money and use up the money in meeting their needs and wants. The Savers occupy the second rung on the ladder; savers earn money, they spend part of the money on their needs and wants, and they keep a part of the money is safekeeping for emergencies and the proverbial raining days.
The third set of people on the financial ladder is the Investor. Investors earn money, they spend a part of the money on their needs and wants, they save part of the money for rainy days, and they put another part of the money to work in order to multiply their earnings. Interestingly, many people are spenders because oftentimes, their earnings are not enough to meet ends meet – talk less of having an extra to save. Savers are doing a better job, but unless you start saving heavily and early, inflation, might erode the value of your savings after a couple of years.
Many people find it very hard to make the jump from being a spender to becoming a saver. For most people however, becoming an investor can be equated to teaching nuclear astrophysics to a toddler. Yet, it’s never too late to start investing. This piece seeks to break down the process of investing so that you can propel yourself to the highest rung on the financial ladder.
Build a Safety Net
The first thing you should do before you set out on the investor’s journey is to build a safety net into your finances. A safety net can be a sort of financial insurance that could make your journey as an investor smoother. Firstly, the safety can give you the peace of mind that comes from knowing that you’ll have something to fall back upon even if you lose all of your investment. Secondly, a financial safety net can make it easy for you to take bold (riskier) investment decisions that have odds of bigger returns.
A smart way to build a safety net into your finances is to create an emergency fund that could cover between three and six months of your regular expenses. You could leave the fund as cash stashed away in another bank account. A smarter move might be to convert that cash into a safe-haven investment such as gold – you might be catch a lucky break and see the value of the gold rise especially if other assets crash.
Smart Asset Allocation
The second step is step towards smart investing is to take up smart asset allocation practices. Many people are incapacitated from investing because they don’t know the kind of assets that they ought to buy. In simple terms, you need to diversify your investments so that a crash of an asset class doesn’t bankrupt you. Investors typically diversify between stocks, bonds, precious metals, ETFs, real estate, and mutual funds.
Smart asset allocation requires you to limit your risk by spreading your money among different types of investments. If you are young, you should keep most of your investments as stocks (volatile), some bonds (medium volatility) and a bit of cash or other liquid assets (low volatility). Investors in Middle Age should buy more stocks than bonds and they should have more bonds than cash. Investors closer to retirement should have most of their investment as cash or other liquid assets and they should have more investments in bonds than in stocks.
Developing the Investor Mindset
Another thing that makes it hard for people to graduate from becoming investors is that they don’t understand how to develop the investor mindset. You’ve probably heard about unassuming “next door millionaires” that have about $5M in investments and you start to wonder how they achieved the remarkable feat. The key to developing the investor mindset is to schedule regular automatic transfers from your bank account into your investment accounts.
When you make regular (weekly, monthly, bi-monthly, quarterly) investments, you’ll build a mindset that invests as an habit. It also helps to increase the amount of money that you are withdrawing and investing at regular intervals. It doesn’t matter how much investment capital you are starting with or how much regular investment transfer you are making from your bank account – the most important point is to develop a mindset that invests regularly.
Understanding the Cost of Investment
I would love to tell you that investing is a simple activity in which you throw down some money here and there, watch the assets appreciate, take your profits and jet off to the Caribbean to become a beach bum. However, the truth is that investing requires work and investing costs some money. Before you put your money into any asset, it is important that you understand the cost of investing.
Some of the costs for investing include transaction costs from every time you buy and sell an asset – you should shop around for brokers with the best (not necessarily cheapest) transaction costs. You’ll also pay commissions on other assets and some assets will cost you in terms of spreads. Even if you buy a relatively stable investment such as gold, you should still be ready to pay storage and insurance costs.