When you think of retirement, surely you’re thinking about all the fun and exciting things that you want to do. However, have you thought about how you will be able to afford to do those things? Saving money in a bank account isn’t going to do it. You need that money you’re stashing away to grow. You need some compound interest, and the tool to use is the stock market. Investing in the stock market is one of the best ways (if not the best way) to ensure that you’re able to support yourself in retirement.
In our previous post, we showed why supporting yourself on Social Security alone in retirement isn’t likely. We also discussed financial independence in a separate post and shared that you basically need to save up 25x your expenses to reach it.
In this post (that I begged Omar to help me write), we’re going to give you some simple but powerful information regarding investing. Most people think it’s incredibly complicated but the truth is that it doesn’t have to be. We will be covering:
- Why You Should Invest In The Stock Market
- Setting Yourself Up To Invest
- Automating Your Investing
- Investment Accounts: 401(k) & IRAs
- What To Invest In Specifically: Index Funds
- It Doesn’t Take A Lot To Start Investing & Fees Matter
- The 15% Rule
- Things That Helped Us Along The Way With Investing
- Tracking Your Investments
- Is Investing Really That Hard To Do?
- Final Thoughts
Yes, it’s a lot of information that we’re covering, but we tried to be as concise as possible. So don’t let the amount of the above headings/sections scare you away from this post! Lol.
Disclaimer: We are not financial advisors. We are merely just sharing what is working for us. Please make sure to do your own research and seek the advice of a financial advisor for your own unique situation.
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Why You Should Invest In The Stock Market
Do you recall learning in school the math example of the two brothers who started investing at different times? If not, the first brother invested X amount of money between the ages of 19 and 26 and then stopped. The second brother invested the same X amount of money between 27 and 65. Guess who had the most money saved up for retirement by age 65?
Another good example is, given the choice, would you rather receive $1 million today or a penny doubled every day for 30 days?
Both of these examples are about the beauty of compound interest and can give you a glimpse of what the stock market can do for you if you choose to invest. The stock market has averaged between 10% and 11% since 1926. This is not gambling. You’re not trying to time the market. You are investing in businesses that are trying their hardest to make a profit for their shareholders aka YOU.
Setting Yourself Up To Invest
There are many schools of thought about investing if you still have any consumer debt and/or student loans. If you decide to invest while you’re carrying debt, then you run the risk of pulling that money out prematurely and being penalized for it. If you decide to pay off debt before investing, you miss out on those years of compound interest. You also miss out on the “free money” offered by your employer for your 401(k) match. We understand the arguments for both, so either way, you have to decide what’s best for you.
We chose to pay off all our consumer debt and my student loans before starting to invest again at age 30. Each of us contributed to our 401(k)’s for a short time before we got married. When we re-started investing we did feel like we were behind. However, now that our investments have grown and continue to grow we don’t feel the pain of that decision much more. Besides, we can’t dwell on the past either.
Regardless of if you invest while having debt or if you pay your debt off first, we recommend that you have an emergency fund of at least three months. Why? Because the goal is to not use any of your investment money until you retire. And again, if you use some of the money before then for an emergency, there will be penalties and fees associated with it. If you have an emergency fund then there should be no need to pull any of your investment money.
Another thing you want to aim to do is set up your lifestyle so that you have a large amount of money to invest per month. It’s easier to do this when there’s no car payments, no credit card debt, and no student loans. Having a mortgage where the payment is no more than 25% of your take-home pay can help as well because you’re not stretching yourself thin with your mortgage. And we actually recommend a 15-year mortgage instead of the standard 30-year mortgage.
Automating Your Investing
To help make investing easier, the best thing to do is automate your investing. Doing a budget can help you with this. The better you are at doing your budget the easier it’ll be to see that you can actually afford to invest.
How do you automate your investing? First, choose the amount or percentage that you want to invest. Next, set it up so that amount or percentage is coming directly from your check if it’s going into your 401(k). Or with an IRA, it’s coming directly from your bank account. And literally, that’s it other than re-evaluating periodically.
Investment Accounts: 401(k) & IRAs
There are a couple of different investment accounts to choose from, with the 401(k) and IRAs being the most common.
A 401(k) is a workplace savings plan that lets employees invest a portion of their paycheck before taxes are taken out. The savings in a 401(k) can grow tax-free until retirement. Once you retire and are ready to make a withdrawal, the withdrawal will be taxed. If you choose to invest in a 401(k), invest at least enough to get the match from your employer (if offered). It’s free money.
What’s an IRA you ask? There are 2 main types: Roth IRA and Traditional IRA. A Roth IRA allows you to contribute with post-tax dollars. In retirement, when you pull money from your Roth IRA you won’t have to pay taxes on it. A Traditional IRA allows you to contribute with pre-tax dollars. When you pull money from your Traditional IRA in retirement, you will have to pay taxes on that money.
The max amount to contribute to a Roth IRA for 2019 is $6000 ($7000 if 50 or older). If you go the Traditional IRA route, it’s the same amount. If you invest in both a Roth and a Traditional IRA, it’s $6000 combined ($7000 if 50 or older).
There are income limits for both Roth and Traditional IRAs that you have to adhere by. For more information on IRAs, click here.
What To Invest In Specifically: Index Funds
Once we were debt free except our house and had our 3 to 6-month emergency fund, we were ready to pick up where we left off with our investing. But we wanted to do a better job of it.
After much research on my part (Omar) and Kim’s agreement, we decided that index funds were the best for us. Why? Index funds are incredibly cheap to invest in, and the evidence shows that they outperform the majority of mutual funds managed by a fund manager. You can view that evidence here on the SPIVA scorecard. SPIVA measures the performance of actively managed funds against their relevant S&P index benchmarks. An actively managed fund is a fund that is managed by a person. This person is literally trying to time the stock market and move around the money in the hopes to outperform their benchmark.
If you look at the third and fourth bullet points on the SPIVA scorecard, they’re showing how the vast majority of actively managed funds have fallen short of this goal. And it doesn’t matter if it was over a short period of time or a longer period of time. According to the report, if you invested in an index fund in the past 15 years you would have done better than 90% of the funds out there. That’s like getting a 90 on a test that you didn’t even study for.
When you invest in index funds you aren’t trying to beat that index (like actively managed funds) but only track it, meaning do just as well.
There are several different indexes to choose from. The S&P 500 index fund and the Total Stock Market fund are the most popular. You can choose to invest directly into either fund. The difference between the two is that the Total Stock Market fund contains the S&P 500 plus all the publicly traded medium size and small companies as well. So instead of being invested in just the 500 biggest companies in the US, you are investing in over 3000 large, medium, and small companies in the US.
I prefer the Total Stock Market fund but others still prefer the S&P 500 fund. Regardless, once you start investing, these companies and the employees working in them are trying their hardest to make you money and that’s a beautiful thing.
Here are links to the two funds in Fidelity if you’d like to check them out:
It Doesn’t Take A Lot To Start Investing & Fees Matter
In the past, these mutual funds required a minimum investment of $3000. Considering 40% of Americans can’t afford to pay cash for a $400 emergency, they definitely don’t have $3000 to invest. Today, Fidelity and Schwab have index funds that don’t require a minimum investment. You could literally start with $1.
What makes index funds incredibly popular and effective is that they perform really well against other funds and the fees are incredibly low. The average mutual fund fee is between 0.5% and 0.75%. Using 0.75%, that’s $7.50 per $1000 you have invested. The funds I suggested above have a fee of 0.015%. That’s 15 cents per $1000. As you can see, the average mutual fund is about 50x as expensive as the funds I suggested above with very little chance of outperforming them. Those fees of 0.75% may not seem that bad but they add up over time. Check out this article where they show how an investor could lose almost $600K over 40 years due to a mutual fund with a 1% fee. It’s not JUST 1%!!!!
So, for me, this decision was a fairly easy one. Due to the performance of index funds over the long haul and the crazy low fees to invest in them, the majority of our money is parked in index funds.
The 15% Rule
You should aim to invest 15%, preferably of your gross income. Why 15%? It’s what the experts say. But besides that, it’s a number that’s tough, but achievable. If you invest 15% for the rest of your life then you should be good (depending on when you start).
From personal experience, it’s definitely tough trying to invest when you’re used to having that money in hand or in your bank account. And it seemed daunting trying to get to 15%. When we re-started investing, we started by doing 10%. As our income increased, instead of increasing our lifestyle, we used the money to invest. It took us about three years to get to 15%. However, even if we didn’t reach the goal of 15%, at least we were investing something over the long run. That’s what it’s about.
Tracking Your Investments
When investing in the stock market, try not to check the numbers every day because it takes time for your money to grow. And at times, it can be very frustrating and make you feel like you’re not doing enough, especially if the stock market happens to drop (AND IT WILL DROP). You’re in this for the long haul. Ignore the drops and keep on saving. It will pay off in the end.
We’re currently using Personal Capital to keep track of how our investments are doing and to track our net worth. We’re on opposite ends of the “checking” spectrum. Omar checks pretty often but is doing so less and less while I tend to not look often… at all. But again, it’s all about finding that balance and preparing for your future. Investing has very little to do with what you know and a lot about the actions you take to make it happen. It doesn’t have to be any harder than you make it.
Things That Helped Us Along The Way With Investing
I (Omar) helped us a lot along the way by reading other blog posts and books that discussed investing. We also would talk about it randomly with each other (and sometimes other people). This would lead to more discussions about if we were on the right track and if we could improve in any areas.
Some of the must-read blog posts include:
Some of the must-read books include:
- The Simple Path To Wealth by J L Collins
- The Bogleheads’ Guide To Investing by Taylor Larimore, Mel Lindauer, et al
- The Little Book Of Common Sense Investing by John C. Bogle
Is Investing Really That Hard To Do?
I originally thought investing was hard until I took the time to learn about it. One of the reasons I’m so passionate about investing is that I see it as a good way to get to financial independence. I’ve spent years learning because I want to make the best investing decisions with the limited time that I have. Also, in the event that I die, Kim will receive my life insurance. I want her to know why the current assets we have are invested the way they are and how she needs to invest my life insurance proceeds as well. I don’t want her to fall prey to a shady financial advisor looking to make a dollar.
I too originally thought investing was hard. And guess what. It can still be overwhelming at times, especially since I don’t know as much as Omar. I had to read this post over and over to edit it and make sure I understood the parts Omar wrote. Although I have him to help me along the way, I still feel it’s my personal responsibility to at least understand the basics of investing. Besides, it’s our money and I need to know what’s going on with it and why.
Time and savings rate are the most important factors when it comes to investing. The decision to start investing now or later will impact your future whether you like it or not. You must find the balance between enjoying your life now and saving for your future.
This isn’t all there is to learn about investing. However, most people don’t get turned on by details. If that’s you as well, our advice is to pick a low-cost index fund like the ones above and throw in as much money as often as you can and don’t touch it. Do that for a few decades, get out and stay out of debt, and you’ll build wealth. And more importantly, you would have developed the habits to keep that wealth.