Investing is as simple as creating a budget, picking a balanced portfolio, and sticking to your goals. If you just starting out in your career, or are new to saving, you are probably feeling pretty poor. If you are like me, you probably have student loans, rent that is taking up way too much of your income, car payments, and still want some money to use for going out on the weekends and spending time with friends. I am by no means going to advocate that you sneak alcohol into bars, spend zero money, and pay off all your loans in one year. Most people I know who have done extreme saving regret it in hindsight. What I am advocating you do is to turn your savings on autopilot and forget about them. But to do this you have to make a plan.
First — Create a Budget
It seems obvious, but before you start saving it’s imperative to know what you are saving for. It’s not as difficult as people think. A budget doesn’t mean that you need to map out every expense, but in order to know how to invest and manage risk, you need to set time frames for when you will need the money from your investments. If you’re saving for something that is more than 5–10 years away such as purchasing a home, retirement, your newborn’s college, or a vacation home, your savings should be in riskier investments with an opportunity for greater returns. But if you’re saving for something that has a closer event horizon, such as a new car, wedding, or a vacation you should be investing in things with less risk. A budget also helps you from spending more than you make. Having savings and an emergency fund will help keep you from carrying debt on your credit card. It’s a lot harder to save when you’re paying 20% interest on your credit card bills.
The easiest way to create a budget is to open up an excel document and plug in your monthly income, then start chipping away at it. Start with the bigger costs such as rent/mortgage, car payment, and student loans. Let’s say that after you have plugged in your monthly recurring costs you have $500 left. Figure out what you need for entertainment costs — if it’s $200 a month, work to save that other $300. The best thing to do is to setup an automatic withdrawal of that amount from your checking account into savings vehicles of your choice. Once you have set your savings goals and created your budget, the next step is to determine where to put your money. Below we will talk about how to allocate your savings to meet multiple goals.
Create a Balanced Portfolio
A balanced portfolio is more than just saving, it is also important to eliminate your debt. Credit cards can be useful for rewards points but only if you’re paying off the balance each month. Going back to creating a budget, saving isn’t worth much if you’re paying hundreds of dollars trying to get out from under debt. Saving will provide you with a buffer for when you have unexpected bills or expenses but limiting unnecessary purchases is important too. Investing is about knowing what you are saving for, ideally you are saving for many things all at once.
There can be a lot to keep track of, keeping things simple is the best choice for most people, which means picking two or three investments and automatically putting money into the account each month. Also, talking with a financial planner can be useful. TV commercials, books, blogs, and pieces like this one offer do it yourself advice but sometimes it’s better for a professional to look at your income and help you create a budget and provide savings advice that is tailored to you.
Types of Investments
Stock Market: Don’t pick stocks! If investing apps help you save that’s fine but it’s not the best investment. Instead, pick a company that invests in index funds and has ultra-low fees. My personal favorites are Fidelity’s Zero Fee Funds and Vanguard’s Admiral Funds. I wrote about picking the right balance between investments here. Fidelity’s Zero Fee Total Stock Market Fund (FZROX) is just like it sounds, it charges zero fees to manage and zero transaction fees, which is really quite spectacular. They are also unique in that they have zero minimums to invest. You can put $1 into the fund if you want to — although that would be pointless, but you could. Vanguard’s Admiral Total Stock Market Fund (VTSAX) recently lowered its minimum purchase to $3,000 and has a .04% annual fee. The reason to consider Vanguard’s fund over Fidelity’s is that the Vanguard fund is far more established and comes with Vanguard’s long track record of success. Also, remember that Fidelity is a for-profit company that is still looking to make money. By offering the zero-fund fee, Fidelity hopes you will start investing with them and then purchase higher cost products from them down the line.
The time frame for investing in the stock market should be at minimum three years with five years being a safer time frame. You have probably heard that the stock market on average returns close to 7 percent per year, but that means that stock market could lose 7 percent one year and then gain 21 percent the next. If you look at the last ten years of returns from Vanguard’s Total Stock Market Index fund you can see the wild swings in the fund and the stock market.
In some years it would have been smarter to keep your money in a bank account, like 2008, 2011, 2015, and 2018. However, it would have been much better to have your money in the stock market for the other years. The problem is you (and investment professionals) cannot predict which years will be booms and which will be busts. The stock market also comes with tax advantages because the government only taxes you on the gain when you sell the stocks. This is a big bonus because the money that would have otherwise been paid to the government stays in the stock market gaining value.
Bonds: This is a savings vehicle that traditionally does not earn as much as the stock market but is not as prone to turning negative. If you think you will need your savings in a shorter time period, right on the edge of 3–5 years, this is a good investment. When looking to diversify a portfolio you should have a certain amount of bonds. Like stocks, you can purchase a fund from investments firms like Fidelity or Vanguard to buy bonds from several different sectors, reducing your own risk. Also similar to stocks, bonds also have certain tax advantages.
Certified Deposits (CDs): These are offered by banks and usually have higher interest rates than bank accounts, but not by much. The good thing about CDs is that they have near zero risk and you can lock them into a single rate until you need the money. The down sides are that you have to pay yearly tax on the interest and right now CDs only return around 2–3 percent interest per year.
High-Yield Savings Account: These are mostly online bank accounts that have higher interest rates than most of the big banks. For the most part these are better than keeping your savings in a checking account that is just losing money. I wrote about why savings accounts are unfair here. Don’t keep all your savings here because you won’t beat the combination of inflation and tax, but if you need your savings within 1–2 years it’s a fine place to keep your money.
Miscellaneous Investment Advice
529 Plans: 529 plans are designed to help you save for your child/grandchild’s schooling. These are tax advantaged so that you don’t pay taxes on the increase in your investment if you use the profit for education expenses. You can open an account even if you don’t have kids yet but plan to one day. Also, you can set up 529 plans so family and friends can contribute to them for your child’s birthday or as a Christmas gift. You can set one up with an investment firm like Vanguard or Fidelity and most states administer their own 529 plans. However, if you are investing your 529 in stocks you need to be cautious so your investment doesn’t decrease in value right before you plan to use the savings. I wrote a little bit about that problem in this Medium post.
Health Savings Accounts (HSA): These are the most tax advantaged savings accounts available today. The only requirement to open one is that you have a high-deductible health care plan. You get to take a tax deduction on your contribution and all of the increase in value is tax free. Additionally, you can keep the money in the account as long as you want and if you can afford it, you should not cash out your HSA even when you have health care costs. The only hitch is that you need to have a high-deductible health care plan. You can also set up HSAs through any of the large investment firms. HSAs are the best savings accounts: you can invest in stocks, write off the money you contribute, and the gains are all tax free. The best part is that there is no time period when you need to take the money out. You can let the money increase in value until you retire or just continue to save it. There is no rule for when you use HSA savings to pay for health care costs. If you pay for health care costs out of pocket and three years later you need to dip into the HSA, you can count the withdrawal against the health care cost from three years ago. Just make sure that you are keeping records in case the men in black suits from the IRS question you.
Home Ownership: Owning a home can be a good investment, but for some people it’s better to rent. If you have a big mortgage, you are paying a lot of interest. It might be smarter to wait a few years and instead pay a larger down payment. Additionally, there are many costs and fees that come with home ownership. A good rule of thumb is if you’re not going to live in the house for five years, you might want to rent. But home ownership isn’t all bad. It can be far better than renting if you’re staying in the same place for a few years. Home ownership can also come with tax benefits on the home’s mortgage, increase in value, and plenty of write-offs on improvements. Just make sure that it is part of your long-term budget and plan!