I don’t make a lot of changes to my 401(k) account. Heck, I barely touch the thing. That&rsquo...
Lesson: Investing or Trading, How to Get Started
08/18/2017 2:57 am EST
Stock ownership has created wealth opportunities for millions of investors. How to get started, by Steve Pomeranz, CFP, who is the host of an investment program on NPR affiliates. Look for guides on how to get started trading or investing every Friday on MoneyShow.com.
Most people, either through necessity or a “spend now, worry about it later” attitude, never save and reap the benefits of growing world economies.
I call these the have-nots. Living from paycheck to paycheck, they fail to seize the chance for their money to build upon itself and to create some wealth and security. This lack of savings never gives them the freedom to be unshackled from money concerns and to have enough money to benefit from the better life that money can bring. The pursuit of money, in itself, is not enough. Its real purpose is to help you feel secure, to help you take care of loved ones, and to achieve financial independence.
Those who can save are able—through their 401(k) accounts, IRAs, and other investments—to accumulate money to help protect themselves from unforeseen life events such as bad marriages, health issues, or children’s weddings, for example. These are the haves. These are people who have been and may continue to be the beneficiaries of rising economies and the rising stock values that come with that.
While I grant you that ideas of happiness, success, and wealth vary widely from person to person and communities to communities, it seems safe to say that most of us want to be in the have category. Few of us want to struggle through life and retirement without any savings or assets to fall back on. Unfortunately, the stark reality (even in a wealthy country like ours) is that only a minority of people accumulate enough savings needed to maintain a comfortable lifestyle into their old age. The good news is that it doesn’t have to be that way for you—and a few simple changes and re-thinking can help you climb your way into the “haves” class.
Understanding owning equity
To start, consider putting aside a piece of your working income and investing it. This is the main way to help build wealth because you gotta have money to make money.
Next is to understand something very basic. There are really only two types of investments:
- Owning something, like a home, a business, or shares in a stock or a mutual fund.
- Lending money, like investing in a CD, a money market, or a bond.
Of the two, owning something offers more potential to wealth and financial independence.
Another word for owning something is equity; the equity in your home is a good example. Your home equity is the difference between the worth of your house and the amount remaining on your mortgage. If the house rises in value and your mortgage stays the same or goes down, you gain wealth. Earning wealth this way does not require you to sit at a desk all day working. Your equity becomes more valuable over time, even while you sleep.
That is why, for most people, owning a home will be their greatest wealth creator.
Owning stocks is the same. If the company or group of companies you own (such as index funds or mutual funds) become more valuable, your shared ownership becomes more valuable too. This process takes many years to potentially work. Stock markets have outpaced inflation in the long term throughout history. Long-term stock ownership has created wealth opportunities for millions of investors.
Building wealth begins with saving
Another main difference between the haves and have-nots is that most haves first developed a habit of saving and investing during their working years. The earlier you start saving, the better the probability to develop wealth down the road. There are two main reasons for this building wealth effect:
The compound rate of return on the S&P 500 Index (SPX) has averaged about 8-12% annually – yes, this is an average rate of return so it has happened in a very up and down way. Some years higher and some years wrenchingly lower, but over time the approximate 8-12% has been the average.
The miracle of compound interest allows the money you’ve invested to build on itself. As an example of compounding, consider a retirement account where you’ve chosen to purchase an index fund. When that fund pays dividends, the dividends are reinvested back into the same fund so you buy more shares, and the next dividend is a little greater because you now have more shares, and that builds and builds.
Future earnings are based on the sum of the principal (the money you’ve paid in) plus all the money earned and reinvested, and this results in a gradually steeper and sweeter rate of appreciation in your account. Note that while you also receive the benefits of compounded interest from other investments, the low returns you’ll get these days from money market funds, bonds, and CDs means you won’t get very far with compounding. On the other hand, after several decades of regular deposits made to your savings, the average returns from your stock investments, and the math of compounded dividends, the results can be truly phenomenal.
It’s worth touching on a few details about retirement accounts since they, along with your home, are the common ways to create and grow equity. 401(k)s and the various IRA plans should be designed to grow your money.
Here’s something to consider: Make your investments boring. Nothing sexy, no hot stocks. Just plain vanilla index funds that are invested in a boring way. Why boring? —because fortune may favor the patient investor. So, embrace the boredom!
Also, if your 401(k) plan includes matching funds from your employer, this is one of the best deals you’re going to find anywhere, so it would be foolish not to take advantage of it. Who in their right mind would give up free money?
Here a few more tips for your investments:
Keep it simple & minimize fees and taxes with index funds
Consider investing in a small number of low-cost index funds or ETFs, which are more naturally tax-efficient and have lower fees compared to actively managed mutual funds.
Putting all your money into a mutual fund because it had a great run and beat market returns for the past 2 or 3 years is not a good strategy. Most of the time, these funds may end up being below average anyway, so you might as well stick with a cost-efficient low-cost index fund.
Don’t chase market trends
Timing the market is a job for wishful thinkers, chart technicians, and many charlatans, not for value-minded, long-term serious investors. Unfortunately, the greed and fear which drives intellectual crowd psychology lead otherwise intelligent investors to buy high, sell low, and repeat until broke.
Make retirement savings automatic
Automate transfers from your paycheck into your retirement or savings accounts. If you don’t see the money first, you’ll grow accustomed to managing your life on a lower monthly budget.
The bottom line is to position yourself to become a have and the only way to get there is to start building equity. If it makes sense for you, consider buying a home, starting a business (and succeeding at it), fund an IRA or 401k, or just putting money into a low-cost index fund month after month for year and years. A systematic strategy will separate you from the woes of constant worries and the month-to-month cycle of struggle.
This is something you have to do for yourself. You have to make it a priority, and you have to do it now. Time marches on and the wealth accumulation is reduced for every year that you wait.
To find out more, go to www.stevepomeranz.com
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