This is part two of a four part series on how to invest your money. The main focus of this series of articles is to discuss the psychology of investing, how to get started, finding your strategy, and building your portfolio. I hope this can be a resource for many people who are looking for information on how to invest their money.
Once you have filled out your investor profile, assessed your risk tolerance, and learned about the psychology of investing you can get started with your investment plan.
Now is the time to identify your investment goals. Depending on your age, income, debt load, and current financial situation your goals may vary over time. Establishing an emergency fund, saving for a trip, setting aside money for a down payment on a house, or planning for your retirement all require a different approach.
Although you may be eager to get started with an investment plan, you need to determine the following 3 things before moving ahead:
- How much do you need to save?
- What is your time horizon for accessing your money?
- What level of risk are you willing to take to achieve your goal?
Since everyone’s situation is unique, it helps to break this down and identify your short term and long term goals.
Short Term Goals
An accurate time frame for short term investing goals is between 0-60 months. With a short term goal, you want to ensure that your principle is protected, while earning you more interest than the average personal savings account.
The best way to do this is to put your money in a lower risk investment option such as a high interest savings account or a GIC. Remember that you will need this money within the next few years. Don’t take unnecessary risks. The stock market is no place to park your money for the short term because it’s simply too volatile.
Compound interest is a wonderful thing, but it doesn’t benefit you very much over such a short period of time. You aren’t striving to be rich within a 1-5 year time horizon, that just doesn’t happen.
The key to any short term goal is a disciplined savings approach (paying yourself first) and watching those contributions add up until you achieve your goal. Again, safety of principle is of utmost importance here.
If you have $10,000 to invest over a two year time frame and you place it in a 2.5% high interest savings account or GIC, you will end up with $10,506.25 after two years.
If you took that same $10,000 and bought a mutual fund or ETF with the intention of earning 8% a year for two years, you could end up with $11,664 after two years.
Sure, that $1,150 difference sounds like a big deal. But you also have to take into account the risks associated with the mutual fund investment. The fund could just as easily lose 8% each year and leave you with $8,464.
With such a short time horizon you are much better off preserving your capital and focusing on increasing your savings rate rather than trying to chase a few extra percentage points of returns.
Long Term Goals
A long term goal can be classified as something greater than 5 years. For the majority of working adults, the ultimate long term goal is to save for retirement. If you are just starting out and want to set up a retirement fund, I would recommend following similar rules that were outlined in the short term savings goals.
You are not going to earn much for capital gains in the beginning, so you want to focus more on regular contributions while preserving your principle investment. For some market exposure you could set up a pre-authorized purchase plan through your financial institution and invest in a low cost index fund.
Once you have accumulated between $25,000-$30,000 you can start to build your own equity portfolio by purchasing individual stocks. Open up a discount brokerage account and transfer your savings or mutual funds into this account.
The reason I recommend starting with at least $25,000 is because that is the minimum balance you need in order to waive the annual fees at the big discount brokerages.
You will also want some diversity in your portfolio. This amount will allow you to purchase 8-10 individual stocks while keeping your costs per trade under 1% of your total purchase.
Trading can be expensive unless you have a sizeable portfolio or want to open an account through an online brokerage like Questrade.
The process of opening a discount brokerage account is very simple and the trading platforms are relatively straight-forward to use. It is true that almost anyone can be a do-it-yourself investor.
Investing wisely is important to achieve financial stability. Consider other options such as FXCM and learn why foreign exchange
could be the right move for you.
In part three of this four part series on how to invest your money I will talk about finding the right investment strategy for you.