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How To Start Investing In 2016

How To Start Investing In 2016

Investing can be scary. The fear of the unknown always is. And the case for Millennials is worse, especially considering many of them graduated into a financial crisis and witnessed the stock market plummet nearly 40% in 2008. That kind of traumatic experience sticks with you, just as the Great Depression forced an entire generation of Americans to develop very frugal habits.

However, it’s important that young adults overcome their fears and start investing to secure their financial future. Waiting too long and starting too late can result in not having saved enough for retirement. After all, the stock market doesn’t plunge every other year and investing volatility is why experts always recommend you pick long-term investments, not short-term trades.

Below, we will discuss how to start investing in 2016, including the power of compounding interest, the average return of the stock market over the last 100 years, how to choose a brokerage account that is right for you, and finally, investment tips for beginners who may need some guidance.

Average Stock Market Returns

For starters, let me provide some basic background on expected average stock market returns. Between the beginning of 1900 and the end of 2015, the stock market returned an average 11.53%. To make sure that these dates were not cherry-picked, let’s remember what happened during this time period: two World Wars, the Great Depression, Vietnam War, Korean War, an oil embargo, multiple terrorist attacks, and a number of recessions caused by economic boom and bust cycles.

Even if you decide to solely focus on the most recent recession, including the roughly 37% drop in equities in 2008, the stock market has returned over 8.40% between 2007 and 2015. This is because the drop in the S&P 500 was closely followed by a slow recovery that ultimately helped investors recover their investments and then some. The point is, despite recessions and individual years with negative returns, the stock market averages a strong positive return over time.

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Time in the Market vs. Timing the Market

It is also important to point out that investors cannot time the market. In fact, research shows that a handful of days each year are actually responsible for the majority of the gains in that year.

The chart below, which reflects data compiled by JPMorgan Asset Management, demonstrates that an investor would have earned a 9.22% return if they were fully invested between 1993 and 2013. But if an investor were to have missed the top ten trading days out of ten years, the return would have decreased to 5.49%.

Investing - Time in the Market

    New investors should ask themselves: out of the more than 2,500 trading days in that 10 year period, would you have been able to pick the top 10 highest earning days?

    Start Early – The Power of Compounding

    Another reason why Millennials and young families should start investing as early as possible is the power of compounding. If you aren’t familiar with the concept of “compounding” returns, it is when you earn a gain on your principal the first year, and then begin to earn returns on your previous returns.

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    For example, if you invest $1,000 and earn an average 10% return annually, your investment will grow to $1,100 after the first year. After the second year, you won’t just earn another $100 but $110, for a total of $1,210. And the third year you will earn $121 for a total value of $1,331.

    On a small scale, this doesn’t seem like much, but assume you invest $1,000 per year for 30 years and average a conservative 8% return. Instead of having $30,000 in a checking account, you will have accumulated a little more than $132,000.

    Now let’s make this more realistic – assume you have a Roth IRA and you contribute the maximum (for your age) $5,500 per year for 30 years. At an average rate of return of 10% annually, you will have nearly $1.1 million dollars. But here’s why investing as early as possible is essential – if we change the number of years we’ve invested from 30 to 25, we only end up with $654,000 in retirement. Those final 5 years of investing on a large capital base comprise a significant amount in terms of gains and mean the difference between a comfortable retirement and a strained one.

    Compounding returns are critical to investors because they allow you to turn small principal contributions over a long period of time into large nest eggs. Keep in mind that Albert Einstein called compounding interest “the most powerful force in the universe.”

    How To Choose A Brokerage Account

    Once you’ve made the decision to start investing for your future, you must decide on your investment strategy and how to execute it. There are many brokerage houses or investing platforms available today – some of which have been around for decades, while others have leveraged new technology to offer consumers alternatives to traditional companies.

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    Traditional Investment Management

    A decade ago, investors had to choose between mutual fund managers such as Vanguard, Fidelity, and BlackRock (iShares) and discount brokerage firms such as TD Ameritrade, E*TRADE, and Scottrade.

    Mutual and index fund managers are ideal for passive investors. If you don’t know much about investing except for the basics, an index fund or ETF from Vanguard or Fidelity may be best – both securities use broad indexes as benchmarks and can be a way for investors to mimic returns from the S&P 500, Dow Jones Industrial Average, or NASDAQ.

    On the other hand, if your employer 401K is already held with one of those mutual fund managers, you may want your private investment portfolio to be at a brokerage house. Discount brokers offer a variety of services, but they are ideal for investing in specific securities or trading stock options.

    Nevertheless, most investors aren’t stock-pickers, and evidence confirms they shouldn’t be. Research shows that “actively managed funds lost out to their passive peers in nearly every asset class during the 10 years between 2004 and 2014…”

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    So why pay your financial advisor a costly fee if they are going to have you invested in passively-managed index funds? Enter the robo-advisor.

    What Are Robo-Advisors?

    The robo-advisor is technology’s response to high fees charged by useless financial advisors and planners. Robo-advisors, such as Wealthfront and Betterment, are online wealth managers that provide automated, virtual investment and portfolio management advice without the intervention of a physical human being.

    By asking you a handful of questions regarding your financial goals, risk tolerance, and personal financial circumstances (e.g. income, assets and age), algorithm-based robo-advisors are able to determine your ideal investment plan. Their programs then recommend a number of investment options and allocations, taking into account the need for diversification across different asset classes and geographies. The other benefit to investors is that, because robo-advisors don’t rely on individual advisors to manage clients, their fees are much lower.

    Although both alternative asset managers are cheaper than traditional financial advisors, both companies have pros and cons. If this investment style seems appealing to you, it is crucial investors research and compare Betterment vs Wealthfront to determine which one better fulfills your needs.

    Stock Market Investing Tips – Dos and Don’ts

    Finally, when you pick a platform and start investing, it is important to develop a basic investment philosophy. While each investor has a different risk tolerance and way of choosing his investments, here are a few stock market tips to help you understand the fundamentals.

    • Set long-term goals. Investing is not a get-rich quick opportunity, and taking on too much risk can easily result in financial ruin. Evaluate your age, risk tolerance, time horizon, and financial goals (e.g. income generation, wealth preservation, or growth).
    • Control your emotions. Hope, greed, fear, and passion are emotions that will cloud your judgement. Investing with objectivity will protect you from making costly mistakes.
    • Minimize risk and maximize reward. Don’t take on excessive risk for small gains. Ideally, take on little risk for huge potential gains.
    • Don’t worry about taxes. If you think a stock has overshot its true value, sell. It is better to take your gains and pay capital gains taxes than to lose money holding a stock too long.
    • Buy best-in-class companies. Unless a mediocre company is deeply misunderstood by other investors, always buy the best and strongest companies in an industry.
    • Don’t be afraid to hold cash when you don’t see any bargains in the marketplace.
    • Don’t believe the hype on Wall Street and always be skeptical of financial analysts. They have a vested interest in keeping you invested, especially when they have positions in the names they are advertising.
    • Don’t let a financial advisor convince you to make an investment you aren’t comfortable with. If the investment, company, or industry doesn’t make sense to you, why invest in it?
    • Life insurance is not an investment. Unethical financial advisors make exorbitant commissions selling whole life insurance, which they claim is an investment opportunity with guaranteed returns. The high premiums you pay outweigh any returns you may earn. Term life is the best life insurance you can buy, then take your savings and invest in an index fund.

    Final Word

    Starting anything new can be intimidating, but that’s no excuse to procrastinate and avoid securing your family’s financial future. To eventually reach financial independence, young adults and families need to start investing early to take advantage of time and compounding returns. If you are skeptical or fearful, starting small is an option. Ultimately, successful investing is all about taking simple steps and executing on fundamental principles on a regular basis. Let 2016 be the year you begin your journey to financial freedom!

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    Gary Dekmezian

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    Last Updated on September 2, 2020

    How to Set Financial Goals and Actually Meet Them

    How to Set Financial Goals and Actually Meet Them

    Personal finances can push anyone to the point of extreme anxiety and worry. Easier said than done, planning finances is not an egg meant for everyone’s basket. That’s why most of us are often living pay check to pay check. But did anyone tell you that it is actually not a tough task to meet your financial goals?

    In this article, we will explore ways to set financial goals and actually meet them with ease.

    4 Steps to Setting Financial Goals

    Though setting financial goals might seem to be a daunting task, if one has the will and clarity of thought, it is rather easy. Try using these steps to get you started.

    1. Be Clear About the Objectives

    Any goal without a clear objective is nothing more than a pipe dream, and this couldn’t be more true for financial matters.

    It is often said that savings is nothing but deferred consumption. Therefore, if you are saving today, then you should be crystal clear about what it’s for. It could be anything, including your child’s education, retirement, marriage, that dream vacation, fancy car, etc.

    Once the objective is clear, put a monetary value to that objective and the time frame. The important point at this step of goal setting is to list all the objectives that you foresee in the future and put a value to each.

    2. Keep Goals Realistic

    It’s good to be an optimistic person but being a Pollyanna is not desirable. Similarly, while it might be a good thing to keep your financial goals a bit aggressive, going beyond what you can realistically achieve will definitely hurt your chances of making meaningful progress.

    It’s important that you keep your goals realistic, as it will help you stay the course and keep you motivated throughout the journey.

    3. Account for Inflation

    Ronald Reagan once said: “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” This quote sums up what inflation could do your financial goals.

    Therefore, account for inflation[1] whenever you are putting a monetary value to a financial objective that is far into the future.

    For example, if one of your financial goal is your son’s college education, which is 15 years from now, then inflation would increase the monetary burden by more than 50% if inflation is a mere 3%. Always account for this to avoid falling short of your goals.

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    4. Short Term Vs Long Term

    Just like every calorie is not the same, the approach to achieving every financial goal will not be the same. It’s important to bifurcate goals into short-term and long-term.

    As a rule of thumb, any financial goal that is due in next 3 years should be termed as a short-term goal. Any longer duration goals are to be classified as long-term goals. This bifurcation of goals into short-term vs long-term will help in choosing the right investment instrument to achieve them.

    By now, you should be ready with your list of financial goals. Now, it’s time to go all out and achieve them.

    How to Achieve Your Financial Goals

    Whenever we talk about chasing any financial goal, it is usually a two-step process:

    • Ensuring healthy savings
    • Making smart investments

    You will need to save enough and invest those savings wisely so that they grow over a period of time to help you achieve goals.

    Ensuring Healthy Savings

    Self-realization is the best form of realization, and unless you decide what your current financial position is, you aren’t heading anywhere.

    This is the focal point from where you start your journey of achieving financial goals.

    1. Track Expenses

    The first and the foremost thing to be done is to track your spending. Use any of the expense tracking mobile apps to record your expenses. Once you start doing it diligently, you will be surprised by how small expenses add up to a sizable amount.

    Also categorize those expenses into different buckets so that you know which bucket is eating most of your pay check. This record keeping will pave the way for cutting down on un-wanted expenses and pumping up your savings rate.

    If you’re not sure where to start when tracking expenses, this article may be able to help.

    2. Pay Yourself First

    Generally, savings come after all the expenses have been taken care of. This is a classic mistake when setting financial goals. We pay ourselves last!

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    Ideally, this should be planned upside down. We should be paying ourselves first and then to the world, i.e. we should be taking out the planned saving amount first and manage all the expenses from the rest.

    The best way to actually implement this is to put the savings on automatic mode, i.e. money flowing automatically into different financial instruments (mutual funds, retirement accounts, etc) every month.

    Taking the automatic route will help release some control and compel us to manage what’s left, increasing the savings rate.

    3. Make a Plan and Vow to Stick With It

    Learning to create a budget is the best way to get around the uncertainty that financial plans always pose. Decide in advance how spending has to be organized

    Nowadays, several money management apps can help you do this automatically.

    At first, you may not be able to stick to your plans completely, but don’t let that become a reason why you stop budgeting entirely.

    Make use of technology solutions you like. Explore options and alternatives that let you make use of the available wallet options, and choose the one that suits you the most. In time, you will get accustomed to making use of these solutions.

    You will find that they make it simpler for you to follow your plan, which would have been difficult otherwise.

    4. Make Savings a Habit and Not a Goal

    In the book Nudge, authors Richard Thaler and Cass Sunstein advocate that, in order to achieve any goal, it should be broken down into habits since habits are more intuitive for people to adapt to.

    Make savings a habit rather than a goal. While it might seem to be counterintuitive to many, there are some deft ways of doing it. For example:

    • Always eat out (if at all) during weekdays rather than weekends. Weekends are more expensive.
    • If you are a travel buff, try to travel during off-season. You’ll spend significantly less.
    • If you go shopping, always look out for coupons and see where can you get the best deal.

    The key point is to imbibe the action that results in savings rather than on the savings itself, which is the outcome. Focusing on the outcome will bring out the feeling of sacrifice, which will be harder to sustain over a period of time.

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    5. Talk About It

    Sticking to the saving schedule (to achieve financial goals) is not an easy journey. There will be many distractions from those who are not aligned with your mission.

    Therefore, in order to stay the course, surround yourself with people who are also on the same bandwagon. Daily discussions with them will keep you motivated to move forward.

    6. Maintain a Journal

    For some people, writing helps a great deal in making sure that they achieve what they plan.

    If you are one of them, maintain a proper journal, where you write down your goals and also jot down the extent to which you managed to meet them. This will help you in reviewing how far you have come and which goals you have met.

    When you have a written commitment on paper, you are going to feel more energized to follow the plan and stick to it. Moreover, it is going to be a lot easier for you to track your progress.

    Making Smart Investments

    Savings by themselves don’t take anyone too far. However, savings, when invested wisely, can do wonders.

    1. Consult a Financial Advisor

    Investment doesn’t come naturally to most of us, so it’s wise to consult a financial advisor.

    Talk to him/her about your financial goals and savings, and then seek advice for the best investment instruments to achieve your goals.

    2. Choose Your Investment Instrument Wisely

    Though your financial advisor will suggest the best investment instruments, it doesn’t hurt to know a bit about the common ones, like a savings account, Roth IRA, and others.

    Just like “no one is born a criminal,” no investment instrument is bad or good. It is the application of that instrument that makes all the difference[2].

    As a general rule, for all your short-term financial goals, choose an investment instrument that has debt nature, for example fixed deposits, debt mutual funds, etc. The reason for going for debt instruments is that chances of capital loss is less compared to equity instruments.

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    3. Compounding Is the Eighth Wonder

    Einstein once remarked about compounding:

    “Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t… Pays it.”

    Use compound interest when setting financial goals

      Make friends with this wonder kid. The sooner you become friends with it, the quicker you will reach closer to your financial goals.

      Start saving early so that time is on your side to help you bear the fruits of compounding.

      4. Measure, Measure, Measure

      All of us do good when it comes to earning more per month but fail miserably when it comes to measuring the investments and taking stock of how our investments are doing.

      If we don’t measure progress at the right times, we are shooting in the dark. We won’t know if our saving rate is appropriate or not, whether the financial advisor is doing a decent job, or whether we are moving closer to our target.

      Measure everything. If you can’t measure it all yourself, ask your financial advisor to do it for you. But do it!

      The Bottom Line

      Managing your extra money to achieve your short and long-term financial goals

      and live a debt-free life is doable for anyone who is willing to put in the time and effort. Use the tips above to get you started on your path to setting financial goals.

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      Featured photo credit: Micheile Henderson via unsplash.com

      Reference

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