I’ve been investing for myself for the past year when I started earning more than my spending. I’ve learned a few things and I want to share them so that anyone with a few thousand dollars in savings can begin investing as the New Year is just around the corner.
First, it’s not about the amount you earn, it’s about the amount you save. Someone with $100,000 annual income and spends $90,000 will only have $10,000 left for investing. Whereas, someone with $50,000 annual income and spends only $25,000 will have $25,000 left for investing. This is a lifestyle choice you can make. Take buying a car as an example. A car is the second highest expense you’ll have in life. First being a residence. There’s no need to buy a $50,000 car when a $20,000 car will get you to the same destination in the same amount of time. You’ll come ahead $30,000 richer in the end. Also keep the car as long as you can so you can get the maximum value out of it. My point here is saving is very important and you want to save as much as you can, especially in the early stages of your life.
This brings me to my second advice, which is put your money in an investment vehicle that maximizes the power of compounding interest. Compounding interest is when interest builds on top of interest. $100 invested at a 5% compounded annual rate will get you $105 in the first year. In the second year, the 5% rate will apply to $105, not just the $100. This is very powerful and you can do a mathematically exercise to draw three graphs. The first graph is an investment with $100 annually with no interest. Compare that to a second graph of $100 with 5% annual compound interest. Lastly, a third graph of $100 with 10% annual compounding interest. Track all three graphs for a 50-year period and you can see the effect dramatically.
Now that we know the power of compounding interest, the hard part is finding an investment vehicle so that we can get maximum amount of compounding interest. Most people think of buying a house is a good investment. In the 1990’s that was a good idea since the housing market was rising significantly. Right now it’s not such a good idea and here’s why. To avoid higher payments, you should put in a minimum of 20% of the house price. This is called a down payment. An average starter house costs about $150,000. This means you need to have at least $30,000 for the down payment. This does not include the closing costs that you have you pay when buying a house. So you’ll need at least $35,000 to $40,000. That’s a lot of money if you’re just starting out in your 20s or 30s. Also the return on your house may not be as high depending on the housing market. Plus the annual property tax and the house repairs you’ll mostly have to make, it’s a gamble to buy a house right now, especially when you can’t make the down payment.
So if housing is out of the investing question, then what should you buy? Luckily, in the last few years investing in the stock market has never been easier. So easy that there’s little or no fees to start investing. There’s an app called Robinhood that’s on the iPhone and Android that allows you to buy stocks without commission fees. You can easily track your stocks on there. Let’s say you saved $1000 and you want to buy some stocks. The price of a stock can range a lot so I suggest buying a stock of a company that you heard of. Even better, you should buy a stock in a company that you frequently use. If you like Nike products then buy some stocks in Nike. Let’s say you want to buy Nike. Its current price is $63. You can buy 15 Nike stocks at a price of $63 each. You just spent $945 without any commission fees on Robinhood. The way Robinhood makes money is they take the leftover amount, in this case $55, and use that to make their own profit. But the $55 is still yours so you’re not losing that money. Later you can use it to buy a $55 or less stock or save it to add to your account when you deposit more money into Robinhood later.
Why didn’t I recommend investing in bonds? Right now, if you’re in your 20s or 30s, you can afford to risk losing money because you’ll have your 40s and 50s to make up for it. Not true if you’re already at retirement age. Stocks offer higher returns than bonds and it’s much easier to purchase, especially when you can do it on your smart phone. For bonds, you have to typically buy from a bank and save the bond in a safe place for years before you can cash it out to get the maximum value. Compared with stocks, buying bonds is the lesser investment vehicle.
What if you don’t want to put all your eggs in one basket, such a single Nike stock? Great question. There’re mutual funds and index funds you can buy. Until recently you had to go to a bank, get a broker, and pay fees. Now it’s much easier to diversify your money in stocks. I recommend two services, Betterment and Wealthfront. They are robo advisors, meaning they use computer algorithm to determine the best portfolio of stocks for you to buy. If you had another $1000 to invest, I suggest put it in Betterment or Wealthfront. Their fee is 0.25%, which only cost you $2.50. I think this cost is worth it because you have your $997.50 diversified so you don’t have all your eggs in one basket.
If you get another $1000, put it in the other robo investment company so your money is now in both Betterment and Wealthfront. This will make you diversify your money even more. I would start tracking which company gives higher returns: the Nike stock in Robinhood, Betterment, or Wealthfront. Then I would add in money accordingly, maybe buy another stock in Robinhood from a different industry, such as a technology stock.
Make sure you’re only investing the money you can afford to lose. This means keep saving and have around $3000 to $5000 in your checking account for emergencies. Keep putting money into stocks in Robinhood and the robo investment accounts. Learn more about stocks and see if your selection of stocks can beat the returns in either of the robo investments. This will make you a savvy investor in the long run. With every stock you purchase, make sure that they are in different industry so your stocks are diversified. Don’t cash out just because the stock goes up or down. Keep the stocks for at least a year before selling to avoid penalties.
What I did:
Around this time last year I started buying stocks on Robinhood. Last summer I bought more stocks through Robinhood because I was saving more money. Total to date, I’ve bought $6000 in stocks in six different companies. They include Facebook, Twitter, Corning, Charles Schwab, Atlassian, and Under Armour. Five out of the six stocks went up and only one went down, which is pretty good. I don’t do any kind of intense financially analysis, which is a fault of mine. Under Armour stock went down because it had debt and other things that I just didn’t realize. You can quickly search for a company’s financial statements on Google Finance and read about them. Bottom line, make sure the company is profitable and has little or no debt. That’s the lesson I learned from Under Armour. My stock return, after a year of investing on Robinhood is now over $7000, a $1000 increase or a 16% return. I recently decided to put in $2500 each in Betterment and Wealthfront. I don’t know which service is better so I split up my $5,000 investment. I also want to see if my $7000 Robinhood account will have a better return than either the Betterment or Wealthfront accounts in 2018.
I might invest in a house in 2018. Note that I wrote invest in a house. I plan on buying a small house and rent out all the bedrooms, except for the one I live in, so that the rent can pay for mortgage, utilities, repairs, and property tax. That way I pay $0, or near it, for rent. Hopefully I can save some money from the rentals if things work out right.
If all this sounds too complex, it’s really not. Buying stocks has never been easier using Robinhood. Diversification has never been easier using Betterment or Wealthfront. All this can be done on your smart phone or computer. It all starts with some savings and keep a good habit of investing while you’re young. Remember the Chinese proverb: Journey of a thousand miles begins with the first step. In this case, Journey of $1,000,000 begins with the first investment.