Many investors, both new to investing and seasoned having spent lifetimes investing, don’t always realize the different roles that investing their money and saving their money play in their financial strategy when planning for their future. Investing and savings each have a very important place in every person’s individual portfolio, but each has an entirely different role to play in your overall money strategy. Your savings has a different purpose and plays a different role in your financial strategy than that of investing your money. Making sure you are clear on this fundamental concept before you begin your journey to building wealth and finding financial freedom is vital because it can save you heartache and stress down the road.
Investing is not about getting rich. It is about building a financial future where you will be able to support yourself for the rest of your life once you stop working. Having the funds available to support your lifestyle during retirement can mean the difference between living life on your terms and living life in fear that an emergency could arise that would ruin your ability to live comfortable. All of this is can be addressed when creating your personal money portfolio.
Every money portfolio should be individually tailored in a unique asset allocation for every individual or family. For you, this will be based on your investment time horizon (the length of time that you will need money, also known as the rest of your life) and your risk profile (the measurement of how your head and heart can deal with the volatility of the cycles of the economy). Knowing these two considerations will help you create an asset allocation that will be right for you. This allocation should be reevaluated on a regular basis, at least annually.
To keep this simple, let’s put capital market into three groups. These three groups are made up of cash, bonds, and stocks. There are many different vehicles out there that offer different ways to invest your money (mutual funds, exchange trade funds (ETFs), annuities, life insurance, and more), but when you pull back the fancy wrappers on these products, you will find that at their core, these are cash, bonds, stocks, or a combination of the three. (We will take a journey down that last road another time.)
Let’s define cash in the simple sense: cash is any debt security (checking account, savings account, money market account, certificate of deposit, bond or treasury) that is payable immediately or within the next 12 months. Essentially you are lending your bank, your credit union, a corporation, or a government entity money on a very short term basis. Once you figure out the asset allocation of your portfolio, the cash amount should be set to an amount equal to your living expenses for the next three to twelve months plus anything extra that just makes you feel safer. There is no right or wrong answer here; it is whatever makes you the most comfortable and what can be supported by your risk profile.
Bonds are very similar to cash. They are longer term loans to a bank, credit union, corporation, or government entity, which these entities have to pay back over a time period greater than twelve months. Creating a bond portfolio, laddering mid- and long-term CDs or treasuries for different maturities and rates finding a professional management company to do the work for you are all good options for creating your bond portfolio. This is the money that you will need in the next two to ten years. These are conservative investments that are earning you a little more interest or yield than cash and have a little more volatility than cash, as the immediate prices change with interest rates. You should keep a set percentage of your total portfolio in these types of investments. These investments will help supplement your income if needed over the next two to ten years. Should you not need the income you will reinvest it based on your asset allocations when they become due.
Stocks on the other hand are an entirely different animal. Here you are observing that the owners of companies earn all of the money. In buying a stock you are buying a small fractional piece of a company and are entitled to that fraction of the company’s earnings or growth. Stocks have high volatility in the short term, moving unpredictably in their day-to-day pricing. Over the longer term a well-diversified stock portfolio will provide a more predictable rate of return. The money that you are looking to invest in the stock market should be the money that you want to access after a time period greater than 10 years. This money is earmarked for the long term, the money that you invest here is money that you are not going to worry about or touch on a regular basis.
If you set up your portfolio on a percentage basis, having a set percentage of your assets allocated to each asset category you or your advisor should be rebalancing the portfolio based upon the guidelines that you set up. What that means is that you will periodically buy and sell assets within your portfolio to maintain the original level of allocation. If you originally set up your portfolio in the following manner: 10% cash, 30% bonds, and 60% stock and the stock market had several good quarters where the prices of your stocks went up while bonds and cash remained at their same price levels your portfolio percentages could have changed to something like: 7% cash, 18% bonds, and 75% of the value in stock. At this time you would rebalance, selling a percentage of your stocks and allocating those funds to your cash and bonds to mirror the original allocation set. The same is true if the stock market takes a large drop in value and your new allocation becomes: 20% cash, 40% bonds, and 40% stock. At this time you would sell some of your bonds and invest some of your cash to buy stock. This practice will assist in reducing the downside risk in extreme an extreme market volatility environment.
If you are looking for ways to invest it is probably easier than you imagined. You could be able to start investing at work tomorrow. Begin by looking at your company’s 401(k), 403(b), 457(b), or whatever your company has available for you. Know what type of retirement plan your employer offers and learn about that plan. Talk to a financial professional about your plan, and know what that plan offers so you can know how best to diversify your options within that plan to match your predetermined asset allocation. Also, employers that offer retirement plans will often match a percentage of your income, if you are investing in the plan.
If you are working for a company that offers a 401(k) or some type of retirement and your employer is matching contributions to this plan, you should maximize your contribution. If you are not investing at least as much as the employers’ matching contribution, you are saying no to free money.
Pay yourself first, make your savings and investments automatic. Then enjoy the benefits of compound interest, market growth, and knowing that you are taking steps to invest in a better financial future.
Achieving financial freedom, whatever that means to you, is not complicated. It takes time, knowledge, and discipline. There is no right or wrong way to invest, it is all personal preference. What matters most is that you start sooner rather than later. Begin your journey today to make your tomorrow more financially secure. Talk with a professional, do your due diligence, and read up on how to make the best plan for you.
Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.