I’ve created this guide for the absolute beginners out there. You don’t know where to go and what to do. You want a practical guide minus the fluff. This one is for you.
Just like a good workout, there are 3 parts to this guide. It’s easy to remember too: pre-action, action, and post-action. You’ll go from an absolute beginner to a participating investor.
Part One: Pre-action
Before you do anything, you need to get aligned with your goals. An investor without a plan is lost and will make bad, emotional decisions.
Every investor should know how much they want to make, and have realistic expectations for their results.
I’m going to tell you right now that an average return of 10% per year is a reasonable goal for your results. The market averages about 8% a year, and some popular mutual funds boast to make 12%.
You need to know this, so you don’t try to chase 20% or more. It will take so much more risk to try and make those kind of returns, and at that point you might as well buy lottery tickets. I don’t support that kind of “investing” and you need to be clear about that.
True wealth is built over time, and that’s the key to investing. When you compound returns of 10%, your money multiplies faster and faster every year.
You don’t win baseball games in the 1st inning, you win them in the 9th. With investing, you don’t win in the first year, but you win in the 10th year and more.
The ultimate goal of investing is to be financially independent. Financial independence means being able to live off of your investments. It’s when your investment money is making you money, so you don’t have to work again!
This may sound like fantasy, but it’s totally possible FOR ANYONE. The problem is that so few understand this so they live in poverty forever. I’m going to help you achieve this. Here’s how the good life can become your life.
Pre-action: The 25x Goal
What’s your annual income, right now? That’s the goal you need to set. But it’s not your total goal, this number is how much you want to receive from dividends.
Without getting too deep into theory, I want to explain that you can receive income by buying stable, dividend paying stocks. It’s pretty common to be able to find stocks that pay 4% dividends or more.
Since we know your investment portfolio can make at least 4% in income, we just need enough money so that this income alone can support you. Basically you need 25x of your annual income in your portfolio to make this possible. It sounds like a lot at first but as you’ll soon see it’s very achievable.
The average Joe making $50,000 a year would need 25x, or $1,250,000. 4% of $1,250,000 in dividends is then $50,000 of income a year. You can see how this becomes an ideal lifestyle. You get paid $50,000 a year while your $1,250,000 stays intact [or can even increase].
How much do you need to invest to get to 25x (assuming 10% returns)? I’ve done the calculations for you below.
You can see how compounding starts to lose its effect at age 40– with 25 years until retirement. What is nice about this chart is that you can give yourself 5 years by pushing your retirement back to 70.
For example: A 40 year old could decide to retire at 70 and therefore would only need to invest 14%– instead of 25%– of his income to meet this goal.
Remember these numbers are for the 25x goal. If you are already 45 or older you may want to set a lower goal for yourself, and you can easily calculate your own goal here. The 25x goal is ideal because it allows you to live on your current income without drawing from your balance, but it may not be ideal for you.
Also remember that this chart assumes your income never increases, or that you need 100% of your current income to survive. It isn’t uncommon to make 12% returns or greater in the market, which would help the numbers even more. These are clearly worst case scenarios, yet even with that in consideration most young investors can easily make the 25x goal.
Part Two: Action
Now that you have a goal, you need to open an account and start investing. I recommend investing your money in this order.
1. 401k Retirement Plan
You should contribute as much as you can to your 401k, especially if your company matches. Keep in mind that every 401k is different and has different options, so there is no one size fit all solution.
For those who want to maximize returns and whose 401k doesn’t allow you to choose any investment you want, you may want to just contribute up to the company match and then max out an IRA.
The maximum contribution for 2013 is $17,500 ($23,000 if age 50 or older). This number can change every year and often does. To find out the maximum contributions for your year (if you are reading this in the future), do a simple google search.
2. IRA [Individual Retirement Arrangement]
You can open a traditional IRA or a Roth IRA. The difference is in when you get taxed. A traditional IRA taxes you when you withdraw money at retirement, a Roth IRA taxes you now.
So if you think you will be in a higher tax bracket when you retire than you are now, pick a Roth IRA. If not, you’re better of with a traditional IRA.
There is a max to how much you can contribute into an IRA or Roth IRA. If you are single, the max is $5,500. If you are married, the max is $11,000. Keep in mind that numbers can change every year. To check your own maximums, I suggest this tool.
You have lots of options for brokers. I’ve provided a list of some of the most reputable brokers, some of which I use myself. Click on the logos to open an account, where you will be asked what type of account you want– Traditional IRA, Roth IRA, or Individual Non-Retirement.
$4.95 stock trades
No IRA account minimum
3. Investment Account – Non retirement You should think about this option only if you’ve already maxed out your 401k and IRA. There are no tax benefits with this account, which is why it is the last option. What is nice about this account is that there is no penalty for withdrawing money out before your retirement. The 2 retirement accounts above will face a steep tax penalty for withdrawing early, which I never recommend you do. Similar to the IRA, there are many options for brokers.
$4.95 stock trades
No account minimum
ETrade (For non-U.S. citizens living in U.S.)
$9.95 stock trades
Account Minimum: $500
Once you have an account open and funded, it’s time to get your feet wet and start investing some money. A great, low risk option for beginners is to buy the S&P500 Index ETF, which has the top Fortune 500 companies in the country. The tickers for two well known S&P 500 Index ETFs are SPDR and SPY.
If you want to start investing with individual stocks, I have some totally different guides on that as well. I’d recommend my Investing 101: Stock Market Challenge and my Investing for Beginners guide. I also always recommend educating yourself as much as possible as you go along. There are some great free investing podcasts out there which I listen to and have written about. There are also some fantastic investing books out there which I have repeatedly encouraged you read as well.
Part Three: Post-Action
Once you have some investments in place, the last step is to maintain these investments. What this means is you have to check the status of your investments and also pay attention to any changes to companies you have stock in. Absolute beginners often feel overwhelmed here because they don’t know how frequently to check on these things, so I will address it here.
Some of the most common rookie mistakes are seen by investors who are constantly worried about their accounts. A rookie investor may check his account everyday, and then feel anxious when seeing it drop 5% or so. This rookie investor may even act on this panic and sell his investment too soon. This type of behavior is endemic and also very costly. You must avoid doing this at all costs.
Remember that investing is won from long term holding, not short term frenzied trading. You succeed by collecting dividends and compounding them, and this can only be done by holding long term.
Assess your Portfolio Every Month
What I personally do and what I recommend you do is to check your portfolio once a month. You want to do this so you know what is going on in your accounts. But, checking only once a month prevents you from freaking out and worrying everyday.
As you check every month, realize you will have some down months and you will have some up months. If you can constantly remind yourself that the stock market is volatile and that you are winning every month because you are collecting and compounding dividends, you will have peace of mind that is more valuable than a million dollars.
If you have taken investing into your own hands and have bought some individual stocks, be sure to also check up on these companies at least once every year. I recommend reading through their annual reports every year to confirm that the company’s direction still aligns with your investment plans.
You can do some common sense comparisons with their numbers to previous years in order to ensure that there isn’t a major crisis within the company. I always look for things like: Negative earnings, stopped dividend, or a skyrocketing debt to equity ratio. Again I explain all of this in much more detail with my Investing for Beginners guide and my When to Sell post.
I hope this guide was practical and helpful. I want you to win. So go do it.
**The Practical Guide for Absolute Beginners**
**All Rights Reserved. Investing for Beginners 2013**
**Photo shown above can be found here: Photo Attribution**