The Key to Wealth: Secrets Revealed by an Investment Analyst
Investing is often associated with complex strategies and overwhelming information, but it doesn't have to be that way.
The basics of investing are simple, mastering them can lead to significant financial gains over time.
Now, I work as an Investment Analyst at a reputable investment firm.
In this article, we are gonna move beyond the vague generalizations and delve into the real details.
My goal is to provide guidance on how you can begin investing, which types of accounts to open, and the do's and don'ts of investing.
Avoiding a critical mistake that many people make is vital, as it can save you hundreds of thousands of dollars.
During my early twenties, I faced financial challenges, often finding it difficult to afford a $1 chicken sandwich at Subway.
If you're in a similar situation, the idea of investing might seem out of reach.
If that’s the case, it might be wise to delay thinking about investing for now.
However, before opening your first investment account, there’s two important steps most personal finance experts agree upon, and we'll explore them in detail next.
2 Important Steps
i) Emergency Fund
First, you absolutely must establish an emergency fund.
Take 40 dollars, 50 dollars or 60 dollars each month, put it away and forget about it.
If you can save more, great!
This is to help you start saving enough to cover one month of essential expenses.
Ideally, you wanna accumulate 3 to 6 months worth of necessities, like rent, utilities, groceries and transportation costs.
But you determine the absolute minimum required to sustain yourself.
ii) Debt
Once you build up your emergency fund, addressing debt becomes the next crucial step.
The second step is to prioritize debt repayment and aim to eliminate all debts except for your mortgage.
Specifically, focus on tackling any high-interest debts like credit cards, student loans, and car loans with interest rates higher than 8%, 9%, or 10%.
These two actions alone significantly impact the direction of your personal finances.
Now I won’t lie, it might take years of saving, frustration, and sacrifices, particularly if you have significant student debt like me, as I graduated with $100,000 in loans.
However, once you pay off your final loan, you will be ready to enter the world of stock market investing.
Start Investing
Warren Buffett, the renowned investor known as the Oracle of Omaha, famously stated that his wealth was derived from a combination of factors like being in America and the power of compound interest.
Compound interest is the reason why it is vital to start investing as early as possible.
Over long periods of time, typically 30, 40, or 50 years, the market tends to generate returns of approximately 7% to 8% per year.
This may not seem significant to some, but it holds great importance.
It means that if you do nothing and simply let your investments grow, your money will essentially double every 10 years.
Suppose you contribute $5,000 a year from the age of 25 to 65 and earn an 8% annual return.
By the time you reach 65, your total investment would amount to nearly $1.3 million.
However, if you choose not to invest and instead keep the money hidden away, you would only have $200,000.
The difference in outcomes is significant and can genuinely transform your life.
After paying off my final student loan, I was eager to begin investing. However, I was faced with numerous questions.
- How do I open an investment account?
- Which company should I choose?
- How much should I invest, and in what stocks?
It was really an overwhelming experience. The variety of accounts available, each with different fees and tax advantages, can lead people to get stuck in the details.
So to simplify the process, we’ll break down exactly what you should do once you decide to start investing.
Your First Account
401k Match
In the US, if your employer offers a 401k plan with matching contributions, that should be your first investment account.
Even before paying off your debt, take advantage of this and contribute as much as your employer will match.
After setting up your employer-sponsored 401k plan, next you should consider opening a Roth IRA, provided you meet the income requirements.
Roth IRA
Roth IRAs offer excellent tax advantages, which is why they are often recommended by personal finance experts.
The question then arises:
which companies should you trust with your investments, as there are several companies that come highly recommended.
Personally, I use Vanguard and have suggested it to my wife as well. Vanguard is known for its low costs and minimal fees, which is an important consideration.
Fidelity and Schwab are also terrific options and all three companies offer great services.
Some people inquire about robo-advisors, which have gained popularity and in my opinion, they are perfectly fine.
Now, if you were to choose between Wealthfront, Betterment, or Vanguard, there might be slight differences in fees. Wealthfront and Betterment may charge around 0.3% more, but in the larger picture, it's not a significant drawback.
Personally, I don't find it worth paying the extra fees.
I don't mind that Vanguard has a less user-friendly interface since I rarely log in. What matters most to me is a company that prioritizes low fees.
To keep things straightforward, if you haven't opened an account yet, I recommend going with Vanguard. They offer competitive fees, a wide range of investment options, and make the process of getting started easy.
How Exactly To Invest
Okay, now that you have set up your investment account, the next step is to decide how to invest your money.
It is crucial to approach investing with a well-thought-out strategy rather than following speculative trends or seeking quick gains.
While some individuals may be attracted to high-risk investments like Bitcoin, it is important to understand the realities of investing and avoid making impulsive decisions.
When people think of investing, they often envision investing in specific companies like Tesla.
Some may argue that traditional investments in the stock market with average returns of around 7% are not as lucrative as investing in cryptocurrencies like Bitcoin, which can supposedly yield returns of 50%, or even 60% a year.
However, it is important to examine these claims with a critical eye and consider the basic principles of investing.
If an investment consistently generated 60% returns per year, that initial investment would quickly grow exponentially, surpassing the total wealth available in the world.
Consistently high returns are highly unlikely to occur.
When individuals turn to highly speculative investments, they are essentially admitting that they haven’t found a viable strategy for building wealth and are relying on luck or chance, like buying a lottery ticket.
And that’s not how you wanna do it.
Diversification
Instead of putting all your money into a single company or taking risky bets on speculative stocks, it is advisable to diversify your investments by considering an index fund.
An index fund is a type of investment that combines various stocks, bonds, and other securities into a diversified portfolio, kind of like your grandma’s stew, a pot full of lots of different vegetables and chicken.
Except in this case, it is a mix of investment instruments.
While there is always an inherent risk in investing, this approach helps reduce overall risk exposure.
When it comes to identifying safe long-term investments that can provide a sustainable income in retirement, target date retirement funds are highly recommended.
Target-Date Fund
With target date funds, you select the year in which you plan to retire, typically around age 65, and invest your money in the fund.
These funds are automatically diversified and include a mix of stocks, bonds, and other assets.
They encompass different market sectors and are designed to adjust the asset allocation over time to become more conservative as the target date approaches.
Target date funds generally have low fees since they are often managed by automated systems rather than individual financial advisors.
Many individuals find it remarkable that they can invest in the same target date fund across different accounts such as their 401(k), Roth IRA, and taxable brokerage account.
This simplicity and convenience make target date funds an attractive option for most people.
If you're in your mid-20s, for instance, a target date fund is an excellent choice to maximize your investment potential.
It is a hassle-free way to invest, allowing you to focus on other aspects of life.
If this sounds good to you, then you are gonna love the next part even more!
Allow me to provide details about the specific index fund I personally invest in, as well as the strategies you should consider once you begin investing in the stock market.
The Target Date Fund I Use
Okay, let me introduce you to the specific target retirement fund that I personally invest in through Vanguard.
It's called the Vanguard Target Retirement 2060 Fund.
This fund is tailored for individuals who plan to retire around the year 2060.
Keep in mind that if your retirement plans differ, you would choose a different fund that aligns with your target date.
Looking at its performance over the past decade, it has achieved an average annual return of 8.74%.
Now, once you've invested your hard-earned money, the challenging part begins:
waiting...
Handling your emotions and managing risk tolerance becomes crucial when it comes to building wealth because market growth is not a straight line.
It fluctuates, moving up and down over the years.
Some years may see a 25% increase, while others might witness a 8% decline.
Even if the market is down, it's essential to remember that it has experienced significant growth over the past decade.
Many individuals find it difficult to withstand the market's twists and turns, and the past year has been particularly uncertain with concerns about a potential recession weighing heavily on consumers’ minds.
As a survey by Allianz Life Insurance Company showed 64% of Americans worry about a looming recession, which is up from the previous quarter’s figure of 57%.
Why You Should NOT Time The Market
The fear of a recession is widespread, and some may consider pulling their money out of their 401(k) accounts.
However, I strongly advise against such a decision.
Trying to time the market by withdrawing funds at the right moment and then reinvesting them is one of the worst financial choices you can make.
There are several problems with this approach.
Problem #1:
First, you cannot accurately predict whether the market will go lower or higher.
People often claim that it's obvious, but history has shown that predicting market movements is extremely challenging.
Even during previous periods of uncertainty, such as 2008, 2009, 2010, 2016, 2020, and 2022, people believed they could anticipate market trends, but the reality is that the market behaves in unpredictable ways.
Therefore, attempting to time the market is not a reliable strategy, and it's highly recommended to stay invested rather than making impulsive decisions based on short-term fluctuations.
Problem #2:
Furthermore, even if you manage to withdraw your funds at an opportune moment when the market is high, you will still need to accurately time when to reinvest those funds at a low point in the market.
The reality is you are gonna have to be right twice, which is highly unlikely.
What To Do Instead?
Instead, the solution lies in consistently investing a set amount every month.
Whether the market is up or down becomes irrelevant because the focus is on the long-term perspective.
By setting up an automated investment plan through platforms like Vanguard, Fidelity, or Schwab, you can contribute a fixed amount regularly, such as $100, $1000, or $5000.
This strategy is known as dollar-cost averaging, where you buy a few shares when prices are high and more shares when prices are low.
Over time, this approach tends to yield better results compared to attempting to time the market.
My First Investment Habit
I can still recall the day I made my first investment in the stock market through Vanguard.
Initially, I couldn't resist checking my investment account daily, tracking every fluctuation and observing how they went up and down.
However, I eventually realized the importance of not obsessing over short-term movements and decided to let my investments work in the background.
It turned out to be the best decision I ever made.
Nowadays, I only check my accounts every three months or so to assess the progress.
Over the past eight years, on average, I have achieved an annual return of approximately 8%.
If you had invested $5,000 per year during the same period, you would have earned $13,000 in interest.
One Significant Mistake
And if I were to keep this up, consistently investing my money will only lead to exponential growth.
However, there's one significant mistake that can cost you hundreds of thousands of dollars.
Many people rely on financial advisors, and I want you to go ahead and take a moment and text your parents, right now, and inquire about the fees they are paying their advisor.
When you ask their advisor, let's call him Ben, he will likely defend his services by emphasizing the importance of protecting your parents' money and making informed decisions.
But the truth is, Ben is overcharging your parents.
He is most likely collecting a 1% fee for assets under management, which may not seem like a big deal initially.
However, over the course of a lifetime, if you pay a 1% fee, that’s 28% of your investment return going directly into Ben's pocket.
Did you hear me? 28% of your investment return going directly into the advisor’s pocket.
Some unscrupulous advisors even charge a 2% fee, resulting in over 50% of your returns being taken by them.
For individuals with modest incomes who start investing in their 20s, that could mean losing hundreds of thousands of dollars.
Most of the financial advice we discussed today is quite straightforward:
- invest in a target date fund,
- automate your finances,
- and focus on living your life.
However, if you absolutely need the help of a financial advisor due to some complex or unique circumstances, pay them an hourly fee or project fee, but never a percentage of the financial assets they manage for you.
Okay, as you delve into your personal finances, it's easy to lose sight of the bigger picture—the reason why investing is so important in the first place.
If someone was just starting out on their personal finance journey, what advice would you give them?
I believe money can bring joy, and instead of viewing investing as a tedious chore, I encourage people to envision what their "rich life" would look like.
What are the things they want to do and experience, whether it's traveling to Japan or taking regular fishing trips?
By focusing on your rich life, you realize the importance of having sufficient funds to support your desired lifestyle.
There are various avenues to achieve this, including salary negotiation, starting a business, and of course, investing.
Every year you postpone investing, you miss out on thousands, if not tens of thousands of dollars.
- Ivan