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Investing is a great way to become wealthy. But before we dive in, I want to set a common basis for our conversation.
Have you seen these guys yelling into their cellphones at a stock exchange? At least on TV, I did. It never seemed quite appealing to me.
Have you heard of the guy working at a McDonald’s restaurant and making millions aside with picking stocks after work? Sounds interesting right? Well, I don’t know if these were just fake news but I doubt that this a sustainable way of growing your money.
None of the topics above have much to do with the things you will face as a normal investor. For the latter, I would suppose that it’s even morally questionable to teach you something of his techniques.
I also don’t talk about a way of getting rich quick. It’s about getting wealthy in the end and limiting your risk. You’ll see soon, that protecting your principles is much more important than picking the hottest stock. If done correctly investing is more analyzing and learning from experience than betting on a new company.
You may think right now: ‘But Sir Budget, this actually doesn’t sound cool at all’. Well, you will learn to love it and I want to steal one question from Ramit Sethi to finish this discussion.
Would you rather be sexy or rich?
If you said sexy, I can’t teach you very much. Neither picking individual stocks with my principles nor investing in index funds are really sexy. Anyway, if you want to learn how to get long-term gains of roughly 8% without reading the newspapers and investment magazines daily, I can help you.
If gains are more important and you want to become somewhat of a geek investor and spend a decent amount of time learning, I also can share some of my knowledge with you and show you ways of picking individual stocks by limiting your risk and analyzing and comparing them to your principles.
Caution! I will never recommend any stock picks to you, as I’m not a financial expert. You and only you are responsible for your money. However, I will share my principles, gains and strategies, so you can use them to your advantage.
Why you should start investing
Before we talk about how to invest, let’s get some additional motivation for the topic besides the 8%+ gains.
You have several other options what you can do with your money.
Spending all the money
You could spend all the money right now and never think about it again. Though, this will neither make you wealthy nor is a good security for retirement or the prime of your life. In general, the things you buy (like a new fancy car) will decrease in value heavily right when you leave the store after purchasing them. That said, we need another way to increase our money.
Buying properties like a house
This is also a form of spending money and it’s terrifying how many people think, that their own house is their biggest (and only) investment and an asset.
I will cover this topic regularly on this blog. But to make this clear from now. If you live in your house and don’t make money by renting it, it’s a liability and not an asset. It takes money out of your pocket and doesn’t increase your income.
Using a savings account
A savings account is great if you want to save money for the short- and mid-term. Nevertheless, the gains are simply too small to take-off.
Let me give you an example. If you want to save $10,000 for your wedding in about 2 or 3 years, savings accounts are great. You don’t have to pay fees for buying and selling your stocks and it’s relatively risk-free. Yet, keep in mind that even banks are not 100% secure.
You may also want to save for the down payment of a land property in later years. You’ll need $150,000 in 15-20 years from now. That’s actually a great place to use investments for. The fees are compensated by your gains in a short time and you will soon outperform the savings account. So we DON’T need savings accounts OR investing but we need savings accounts AND investing.
This is actually the first type of investing you could use. Though, it’s the most basic and totally risk-free option. It’s risk-free because the government can print new money if they went bankrupt. There are countries that nearly went bankrupt like Greece. Anyway, in most cases, this is a safe bet.
The gains for government bonds change on a daily basis, you can check them out here. At the time of writing (09-26-2017), they are at 2.53% if you decide to give your money away for 20 years and 2.22% for 10 years. These are pretty small gains. However, we should use these numbers for our evaluation. If you can calculate a growth of 2.6% with a stock and this is not free of risk, it’s actually a bad investment. You’ll learn more about that calculation stuff in later blog posts and I will link to them accordingly.
Real Estate Investing
For many people, the path to wealth and a life of abundance was build by becoming a real estate investor.
You can start small with a duplex and trade up from that. It’s incredible to think of making money through renting apartments or houses and make the same amount of money monthly as on your day job (or even more). The downside is that you need a lot more money to start investing compared to stocks and bonds and mistakes are more crucial.
Don’t misunderstand me, I will get into real estate investing, too. But there are also much national difference and things you’ll need to know. I probably can’t help you on that. But there are great blogs covering this topic like Bigger Pockets or RE Tips by JP Moses. Feel free, to check them out, if you want to become a real estate investor.
Stock & bond investing
It’s my preferred way of making money in the long run. You’ll create a portfolio of several different and diversified stocks and bonds. You can also use index funds if you want to spend less time on research and you are fine with the 80% of the best possible outcome in 20% of your time.
If you want to dive in a little deeper, you can start dividend growth investing. It’s still not much work you need to put in, but a little more than with index funds.
Investing is long-term – short-term is speculating
There are two ways of ‘investing’. You can buy stocks with the goal in mind to hold them for many years. That’s called investing.
Another strategy is to pick stocks and hope or guess they’ll go up soon and sell them afterward. You need to make a decent amount of money in that time as you also have to pay the fees. This is very risky and I don’t know any speculator that was successful with this strategy for several years. That’s the reason why I won’t cover this topic on my blog.
One thing you really need to learn as an investor is to keep your emotions under control. There will be times where your stocks go down for many months. It’s tough to keep motivated at this time and even more important to continue investing in these stocks that you’ve picked. This may seem counterintuitive to buy stocks that go down but it actually isn’t.
When the price of a stock is decreasing it becomes cheaper and you can buy this share of a company for less money. Though, you also want to continue investing when your stocks go on top as you want to make use of dollar cost averaging and limit the impact of volatility. That’s the reason why you should buy stocks every month/quarter. However, you won’t buy a share if it’s price is above the value that you’ve calculated before buying it. Then it’s time to sell as the only way is back down.
You don’t understand what I’m saying right now? That’s fine. It’s a lot to cover and you will learn this in the coming weeks by reading my investment posts. I will also create a starter guide on all the basics you’ll need to know.
Index funds vs. mutual funds
In this blog, I will mostly cover index funds as I think for the average investor they are the way to go.
There is one difference I want to point out directly. Index funds vs. mutual funds. But first, what is a fund?
A fund is a collection of different stocks and you can buy them for the price of one individual stock. You share all the stocks in that fund with other investors. If one stock goes up or down the impact is limited. Overall this is a great way to minimize your risk.
Let me give you a very basic example. The fund contains one share of Apple and one of Ford. There are two shares of the fund (this has nothing to do with the number of companies and shares in it!). You buy one share of this fund (so 50% of the Apple and Ford shares) and your best friend the other. After one year the value of the Apple share increased by $50. In contrast, Ford lost $40 per share. The overall profit is $50 – $40 = $10. As you and your best friend had the same amount of shares of that fund, you both get $5 ($10/2). As you see this is way better than picking Ford in the first place. However, it also limits your profit compared to picking just Apple.
For the average investor, this is a good trade as you can limit your risk, especially if one company goes bankrupt and you will lose everything by picking an individual stock from them.
Now there are two options. The first one is a mutual fund. There is a fund manager that picks all of the stocks (in the above example, he’d picked Apple and Ford). He has a great knowledge of investing. However, as he needs time to manage the fund and pick stocks he will also charge a fee of X% value of your investment each and every year. As funds usually compete for around 8% this could limit your profit to 4% a year or less! Also, this approach is error prone as you don’t know how good the fund manager is and managers often fail to beat the market. In conclusion, it’s not uncommon to have no gains after all.
Index funds work the same way with one simple change. They kill the fund manager. Computers buy stocks by building the portfolio after a certain index (e.g. S&P 500). You have exactly the same stocks as that index has and with the same ratio. If the value company A is twice as much as company B, your index fund will also have twice as much money in company A. You pay a very small fee often less than 0.5% and after all, you can expect an average of around 8% annually.
Remember: An index fund replicates an index.
That’s the reason why I think in general index funds are the better solution than mutual funds. They simply perform better.
Dividend Growth Investing
Have you ever heard about how strong compounding interest is? Dividend Growth Investing is based on this principle. You pick stocks that pay a high yield (dividend/price) and increase this dividend every year. After 9-10 years your dividend payments become huge.
Sure, it’s nice to keep those dividends but you know what? It’s even more impressive to reinvest the dividends. This will increase your monthly contributions and the number of shares you can buy. With that, your dividends will pop off after a few years.
You may say ‘why should I spend all the dividends, I want to use them for X’. That’s right and you should. But there are two distinct phases in dividend investing:
- Accumulation of dividends (Reinvesting)
- Spending of the dividends
Let’s say your goal is to cover your monthly expenses so you can retire early. You buy dividend stocks and take all the dividends that are paid to you and reinvest them to receive even more stocks that will generate dividends for you. With the compounding machine set up after some years, you will receive a large number of dividend payments. As soon as you’ve reached your targeted monthly payment you can live off from that and quit your job. Over the long run, this is a much more sustainable system then using the dividends right away without increasing your monthly contributions.
Note: I don’t suggest that you pick stocks depending on their ex-date (the date when they are paid out). Technically it’s possible to create a dividend calendar and buy stocks so you receive the same amount of money each and every month. However, you want to pick the best stocks and don’t use worse stocks just because they are getting paid out at a specific date.
If you want to start dividend investing and need some book recommendations, I’ve got a small list for you:
This was my first book on dividend investing and it is a decent guide to become a dividend growth investor. It’s entertaining (at least for an investing book), it’s backed by solid studies and data and it is a hands-on guide you can follow. Marc Lichtenfeld tells you about his 10-11-12-system and it really seems to be brutally easy to implement. I’ve already made my first purchases with this system.
Where to start your journey
You will make mistakes in investing and you will lose a little bit of money. However, if you stick to it and you are willing to learn you will also make fortune over the long haul. To limit the mistakes and increase the money you will make, it’s very important to start with the basics.
There is a subcategory ‘The Basics’ in my navigation bar below the category ‘Investing’. You should start here. You will learn the basics of accounting. What is a balance sheet actually? How to read it? What are dividends and how to use dollar cost averaging to your advantage?
However, it’s also great to read all of the posts I’ll publish about investing even if you are a beginner. Some things may not always make sense to you, but the more you read, the more educated you are and the easier it will be to read those advanced articles.
Important! One final takeaway I want to provide you with right now. The sooner you start investing the better it is. This will sound unreal or strange but bear with me.
Let’s assume you are 25 and start investing now as well as you make 8% each and every year. You continue to invest the same amount of money for 10 years and then stop and just keep the money in your investments. A friend of yours does not start investing today as he thinks he can take care of that stuff later. He starts at the age of 35 and also makes 8% a year with the same monthly investing than you did. He continues doing it for 30 years until he is 65. So 20 years more of monthly payments for your friend.
Do you want to know who is richer at the age of 65?
Your friend has made monthly payments for 30 years and you only for 10, but because of the compounding interests, you have more money at the age of 65. This calculation was done for monthly payments of $100 as well as $500 and $10,000 and all of them resulted in the advantage of starting early. I will cover this in a blog post.
What I want to tell you here is that you should start investing ASAP. Don’t wait for it. Even if you are 35 or older, it’s not too late to start.
Thanks and have fun with investing on Budget Like a Sir!