Bear Mountain Bull

Joe and Jane Investor

A lot of people assume incorrectly that investing is all about having money and buying a few stocks. It’s not quite that simple - it takes a lot of time and effort to do the research required to make good investments. But it’s even more than that. The process of investing, and building wealth, is more than just a hobby. It’s really a way of life, one that begins with financial discipline: managing all of your money wisely, whether or not it’s invested in the stock market. You can’t begin to buy stocks if you don’t have money to invest, and you won’t have money to invest if you spend every dollar you bring home.

Here are a few thoughts on managing your household finances: steps you can take to help you move toward building a solid financial foundation:

1. Live below your means. It almost doesn’t matter how much you make, you’ll feel like it isn’t enough. So start the saving habit early—ignore the urge to upgrade at every opportunity whether that means a new car, a bigger house, a better gadget, etc. If you want to have money to make money, you can’t spend all of it. Cutting costs by changing habits creates a lifetime of savings. Some of these saving ideas may actually improve your quality of life! Two of my favorite money saving tips:
• Limit dining out—make cooking a hobby, learn to prepare good meals, and make enough to freeze meals into your own “tv dinners.” Only certain meals freeze well, but stews, casseroles, and lasagna are nice to have available when you are too tired to cook. Cooking can be fun, it’s healthier than eating out and it’s a lot cheaper! Here’s a variety of good, simple recipes to get you started.
• Instead of renting or buying movies, check them out from the library. These days, libraries have good collections of DVDs, VHS, and music CDs. The topics range from popular movies to PBS specials. So long as you return the material on time, you can check these items out for free (your taxes have already paid for the library services!). Many libraries also have free internet access.

 

2. Get out of debt and stay that way. Pay off your credit cards, and never charge anything that you can’t pay for at the end of the month. The only exceptions should be emergencies—and I’m talking medical emergencies, “we’re stranded” emergencies, “the-house-will-collapse” emergencies.
   • Any interest you are paying on a credit card is likely higher than whatever profits you can make over the same period in the stock market. So get rid of the debt first. For example: many credit cards charge interest rates in the ranges of 9% to 21% a year. By comparison, the stock market might average gains of 10% gains per year - over time. If you pay off your credit card, you are guaranteed a savings of 9 to 21 percent—whatever the card charges. And that money is saved at NO risk, whereas that same money could be lost in a stock investment.

     A certain 21% savings is better than a ‘maybe’ 10% percent gain. Boring as it may seem, take care of the sure things. Paying off debt isn’t much fun, and doesn’t provide any instant gratification—but you already expericenced that feeling when you purchased whatever it was that ran the card up - remember?

 

3. Know the difference between “wants” and “needs.” Things that don’t count as ‘needs’:
   • “I need to buy that big screen television now. If I don’t, it won’t be on sale later.” There will always be another sale, and the store will always be happy to take your money.
   • “The house needs new…” Replacing faded curtains, old furniture, ugly appliances or dirty carpeting are not “needs”. Fixing a hole in the roof or a replacing a leaky water heater—that’s a “need.”

 

4. Plan for the priorities. If you know that your water heater, stove, or car battery is going to need replacement soon, start saving early. Don’t wait for it to break. Have a rainy-day fund for these things–money that isn’t locked into an investment or anything else. If you don’t have such a fund, start one. Assume the car will break down, that the tires will go when you least expect it, and that something will go wrong at any minute. Assume that you will need to have a few hundred dollars for that unexpected thing that will happen.
• If you must dip into your savings for a “treat,” replace the money. Never “treat” yourself to the extent that you use up all your reserves. The minute you do so, something will break. It’s one of the laws of the universe. Remember: “need” versus “want.” Getting a fabulous Ansel Adams photograph for your wall isn’t going to comfort you much if your car breaks down. I know fixing the car isn’t fun at all, but having money is—so set your priorities. When you break out of your priorities, pick yourself back up, get back on the wagon and start over.
• How closely you stick to a budget or priorities really depends on your long term goals. For example, if you want to retire early, you’ll need to be a lot more frugal than if you are just saving for a new car.
• Time and again, failure to adhere to priorities is where people have the most problems in reaching their dreams. Countless people I know want money for a down payment on a house—yet somehow along the way, they cannot resist buying a piano, a dog, a car, a new wardrobe—whatever the quick trick of the moment. Recognize that you can’t have it all—no one does. If you pick a priority, you will have to stick with it over a long period of time in order to achieve it. That will often mean giving up some or all of the multitude of other things that catch your eye along the way. There’s nothing wrong with getting those things, but recognize that by buying them you will sacrifice the longer term dream.

 

5. Buying “gifts” for yourself can become a costly habit—an instant gratification fix. Be wary of getting into the habit of “reward” spending. A lot of us get instant gratification—a feeling of happiness—at buying things. We reward ourselves with new shoes, new jewelry, a new light fixture when we want to feel good. You probably know people that buy something every time they have a bad day. “I deserve it. My boss was horrible today, so I’m going to go buy a new pair of shoes to give my spirits a lift!” If spending money on new ‘projects’ or gifts to yourself—no matter how large or small—becomes a habit and part of your emotional support, you will create a cycle that makes it hard to pay off debt, get ahead financially or have enough money to invest. Projects are fine, but don’t let them become an expensive way to make yourself feel good temporarily.

 

6. A house is probably a better investment than the stock market. Before you consider investing in the stock market, consider that paying rent on an apartment is not an investment, whereas a house is. If you have only a few thousand dollars to invest, it makes more sense to use that money for a down-payment on a house than to invest in the stock market if you are attempting to build wealth. If there are outside reasons for not buying a house (plan to move soon, don’t like the area, never want to own a house along with the responsibilities) that’s a different story, but all other things being equal, a house is a good investment. You have to live somewhere anyway and a house is generally a safe investment. You are much more likely to get back your principal in a house than in any given stock.
• If you want to treat your house as an investment—i.e., get the most out of it as quickly as possible— consider getting a 15-year rather than a 30-year mortgage. Your monthly payments will generally be higher, but far from double. The interest rate you pay will generally be lower on a fifteen-year loan, which helps keep the monthly payment lower. With a fifteen-year loan, you will build equity, or “own” more of the house much faster. Always have your mortgage lender run both types of loans so that you know the difference in the payment. Have them list the payments - the amortization table - so that you can see how much principal and interest is paid per month on a 15-year versus a 30-year loan. If you’re worried about not being able to make the payment, consider buying a less expensive house! Remember the goal is to live beneath your means— that is the real way to generate extra cash!

 

7. Don’t be afraid to make an extra house payment as an investment. Once you’ve “bought” a house, you still owe money on it. Using the same logic as the credit card example, consider that each time you make an extra house payment or two, you are saving yourself interest—guaranteed savings. Once you pay off your house, finances become much easier. For most people a house payment is a huge part of their monthly expenses. So before you worry about investing in the stock market, consider taking those extra few hundred investment dollars and paying down the principal on your home.
• Make sure the mortgage company treats your extra payment as a payment on principal and not an “advance” payment. Paying “in advance” would be treated like a normal monthly payment and include interest plus principal. Many mortgage companies will assume you are paying ahead rather than paying down the principal (the remainder of the loan) because they don’t want to give up the interest. Some people do intentionally pay a payment or two ahead in case of a tough month when they can’t make a payment, but as an investment, the entire amount should go to principal, not principal and interest.

 

8. Your first stock investment should probably be your 401k plan.

 

401k Plans

• Almost everyone who works in corporate America has a 401k. That is where I got started in investing in the stock market. It is where I first came across terms like cost-averaging, bond funds, large-cap funds, mid-cap funds, etc. I learned about the stock market by investing in my 401k—asking questions, reading about the terms I didn’t understand and trying different techniques with money that I didn’t need right away. Be warned—learning will mean losing some money. It will also mean gaining some money. Keep track of your good decisions and your bad ones.
• Shockingly, many people don’t pay much attention to their 401k. They look at their statements two or three times a year. That’s a mistake. If you’re interested in the stock market, your 401k is the stock market. Find out what your investment options are and pay attention to them. I’m talking time-consuming research—look up the funds available, find out the past performance and understand what types of stocks or bonds are purchased in the fund. Diversify your investments by putting some money in cash (usually a money market fund), bonds (generally better investments when interest rates are going DOWN or holding steady) and stocks (put some in large capitalization companies–big companies–mid-cap and small cap companies). Keep an eye on the markets, and see if you can detect the larger trends - ups and downs - that take place in the markets. If you can recognize the trends, you may be able to figure out how best to maximize your gains, and limit your losses.

 

9. If you don’t participate in your 401k, start. We’re talking your retirement here and no one is going to do it for you. If your company makes its own stock available in your 401k, avoid the temptation of putting a large percentage of your total investment into company stock. You don’t want all of your retirement invested in a single company.

 

10. If you really want to invest - in your 401k or otherwise - it is going to require time and effort. I spend time on it most days of the week, anywhere from a half hour to an hour. When I was starting out, I probably spent about an hour on it every couple of weeks—investigating what a particular 401k fund was all about, learning the difference between stocks and bonds, figuring out how much money I would need outside of a 401k if I wanted to invest on my own.

 

11. Your portfolio, whether in a 401k or outside investments, needs attention and maybe rebalancing several times a year. It’s like changing the oil in the car. Take care of it and it will last longer. If you want it to grow, it’s like a garden, you have to water it and feed it. Occasionally you get something really good from it, but now and then you might lose a plant or two. Be prepared for that also.
• The key to investing is to start with some money and make it grow. To do that, you must live below your means—you must spend less than you make.
• Take advantage of programs such as a 401k plan to learn about investing. Pick apart the funds and read magazine articles and a couple of books on investing.
• Understand the difference between want and need–don’t run out and buy a new car as soon as the loan on the old one is paid off. A car payment could be a nice monthly sum to invest and grow over time.
• Don’t be afraid to take money and put it towards house payments—either extra payments if you have the money or getting your first house.
• Take time to shop around for the best deals, whether it be on insurance, groceries, or health care.
• Read, study and take time out to work on your financial situation each week!

Article contributed by MES