Learning how to invest the right way is crucial to a successful and profitable portfolio. However, before you invest a single dollar, your first step is to determine what your investment goals are and within what time frame you want to achieve those goals. These goals will be different for each investor, varying by their age, capital available and income levels.
Investment goals are found within a number of broad categories: Lifestyle – making sure your financial needs are covered for your lifetime; Security – protecting your investments from excessive financial risk; Suitability – maintaining a balance between returns and personal risk tolerance; and Value – minimizing the costs associated with managing your investments.
These categories are also divided into:
This is important: the more specific the goal, the easier to identify and more effective will be the necessary investment.
Also, as these goals will be ever-changing as your needs change throughout your lifetime, your investments will need to change as well. Determining and clarifying your goals is the first step towards successful investing.
If you need help defining and mapping your financial goals, visit our Financial Independence Calculator. We built this tool to help our users visualize their financial goals and understand the steps to take to achieve them as efficiently as possible.
Once you have set your investment goals, you need to decide the funds you have available to invest. We all have certain fixed costs that reduces our income: rent or mortgage, car payments, credit card debt, phone and cable bills, and these are all before gas, food, gyms or other personal needs and enjoyments.
This can seemingly leave little discretionary income to invest. Do not lose hope! The wonderful nature about investing is the ability to grow small amounts of money into larger ones without the need for complex or overly risky strategies. Let’s see how.
In the old days – when interest rates were above 5% – you would have a savings account that provided you with compound interest. Compound interest is basically making interest on the initial interest paid over time. For example, if you put $100 in a savings account giving 5% interest, after one year you would have $105, but after the second year you would $110.25 as you received the added interest on the $5 you gained in that first year.
The interest of the prior year is added to the principal. The higher the interest rate the greater the impact and growth. And that keeps building for as long as you leave the money in the account.
However, in the current near-zero interest rate environment, growth in savings accounts through compound interest is limited. Fortunately, there is an alternative: investing in stocks. Over the past 100 years, the stock market has averaged roughly 10% per year. In reality, the market may fluctuate dramatically year to year; however, the longer you stay invested in the market the closer your results will be to the average return. Comparing the different impact of compound interest between a current savings account and the stock market, the advantage of investing becomes clear:
With a $1000 initial deposit/investment and a $100 monthly contribution over 10 years,utilizing a .05% current savings rate and a 10% average stock market return, the total returns (using a Compound Interest Calculator) are
Savings account = $13,030
Investment account = $21,700
The investment account grew 67% greater than the savings account!
As demonstrated, investing can be a powerful tool to increase wealth and does not require large amounts to get started. The key to this step is to figure out how much discretionary income you have available to invest. Funds can also be re-allocated from personal consumption (one less latte or beer a week) or from “underachieving” funds, similar to the savings account discussed above.
A good place to start determining your readily available cash and potential re-allocations is with a basic budget defining your fixed costs and your discretionary spending per month. Creating a simple budget will help identify the current and potential funds you will have to invest each month.
And just as your goals will change throughout your financial life, so too will the funds available to invest change. Paid off debt, wage increases, bonuses all increase the amount of capital you can invest. It is important to periodically evaluate your discretionary income so you may increase your investments and grow your wealth. Now that you know how much you can invest; you need to know how much you are comfortable investing.
In Summary:
Investing your money the right way can be the most financially rewarding thing you can do. Without a doubt, the stock market is the greatest wealth generator in the world. However, diving in blindly without understanding your investment goals can leave you high and dry.
Taking the time to map out your immediate, short-term, and long-term goals is the first step to a successful investment. Once you understand your investment goals, you will be able to make decisions along the way that pave the way for your future.
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