Hello all, welcome back to Budget For FI/RE.
One of the things that I have pondered over the last few decades has been how I can invest in the stock market. On the same thought though, I have contemplated not investing and just keeping my money in my savings account. I can’t lose any money in the stock market if I don’t invest right?
Well, that is certainly one way to think of the stock market and your money, but another way to think about investing in the stock market is… if I don’t invest in the stock market, I am risking “losing” the value of my money due to increasing inflation; or if I don’t invest I risk not being able to increase my money enough to retire with a decent enough account size.
But, the Market Goes Down Every Day!
Yes, you are right. The market has fluctuations every day, and sometimes multiple days, weeks, months in a row. These declines in the market are not something you should fear, as these are normal. The declines I’m talking about are usually less than 10 percent on average, except in rare circumstances. Additionally, when you look at the market as a whole, yes, there may be declines across the board, but those are typically major indexes of companies that may be in specific sectors. Maybe, the decline you might be looking at has to do with a single (or few) large companies that may be having a bad day. Maybe those companies missed their earnings projection by a few cents and investors/traders decided to dump the stock, causing a decline.
While there are declines, these can also be opportunities to buy into the market. These opportunities are plentiful as the market fluctuates day in, day out. However, you want to make sure that you aren’t trying to time the market by buying stocks/ETFs/Indexes when these are down intra-day. Instead, if you are noticing that the market is down over a few days and your desired investment is also down in the same time frame, this may be an opportunity for you to purchase more shares of the desired investment. While I affectionately refer to these times as investments being “on sale,” I often am teetering on the line of trying to time the market. I DO NOT recommend trying to time the market. Doing so will likely cost you more money than you make. So, what do you do with your income?
It’s All About Your Income
Whether you are looking to retire in 10 years or 50 years, retiring is still probably one of your medium- to long-term goals for you and your significant other (if you have one, it’s not for everyone). You have a few choices on how you want to fund your retirement, but my suggestion is to fund it from the returns from your investments in the stock market. So how much do you need to retire? Feel free to go to Google/DuckDuckGo/Bing or any other search engine and type that question in. You’ll find the common number that you need $1million to retire. That may be true! However, it’s not true for everyone. Instead, you may find that you only plan on needing $500,000; or maybe you have decided that you need to have $2million to retire.
These are all valid approaches to your own retirement. I can’t tell you what you need, and neither can anyone else. However, what I can do is suggest ways for you to calculate how much you need in cash/savings/investments altogether or variations. So, I recommend that you take the time to start looking at what you expect your retirement costs to be. This is much easier written/said than done, but I recommend that you seriously take a look at what you believe you will be paying for all your expenses in retirement. Also, don’t forget to include some budget for outings, hanging out with friends, going to concerts, etc.
Once you have an idea of your desired life, take the annual expenses for that life and multiply it by 25. It’s called the Rule of 25. It’s a common method to going to and estimating roughly how much you should have in all investment vehicles to retire at your desired income level in retirement. For example, if you want to retire with $50,000 of income in retirement for all of the things you want to do and all the bills, you would multiply 50,000 by 25 to come to a total of $1,250,000. This is the estimated value of all the investment vehicles that you would need by your retirement age.
That rule may be a little out of date, but it still stands to be a valid estimation point. If you are a bit younger, say, in your 20’s and looking to retire in your 50’s, you may want to use a multiplier of 20. Maybe you want to use a multiplier of 30. These are obviously going to give you wildly different numbers. You need to figure out which multiplier you want to use, and then stick to the number you came up with.
But, It’s Difficult to Meet Those Long-Term Goals with Short-Term Investments!
You are absolutely right! It is very difficult to meet your long-term goals with just short-term actions! That’s why you are going to work on your dedication and discipline to contributing towards your retirement on a regular basis. RIGHT!?
Just as with everything else in life, if you want to achieve your goals, you have to work at them. Do you want to learn a new language? You don’t just pick that up in a single day and are fluent… no, you have to work at it, oftentimes for years at a time. Do you want to learn how to become proficient at playing the saxophone? Well, guess what? You’re going to have to practice at it, likely every day or multiple times a week in order to get better and become a professional at it.
Just like everything else in life, investing is no different, you still have to maintain a dedication and discipline to investing in order for your portfolio to grow to your desired levels. Not all of us can be Mr. Money Mustache and retire in his 30’s, but dang it, I’m certainly going to try!
What I want you to do is to take the time to find a place in your budget to dedicate towards making regular contributions towards your investments. In another blog post titled “Cutting Expenses vs Increasing Income“, I wrote about some things you can do to relieve some of the stress from budgeting and different paths that individuals may take to balance their budget.
So, within your budget, find some expenses you can cut entirely or at least reduce. This is a common first step for many people and is significantly easier than increasing your income. So try this route first. How much can you reasonably (while not completely sacrificing your entertainment budget) dedicate to going towards your investments? Is that only $10 a month? GREAT! That’s certainly a start. Are you able to reduce your expenses and increase your investments contributions by $1,000 a month? AWESOME! That’s certainly going to propel you forward faster than otherwise. However, I realize that this isn’t always the easiest method.
How to Double Your Money!
I admit, that’s a bit of a clickbaity heading, but it’s still fairly reasonable for this topic. Another common rule you’ll come by with hardly any searching online is the “Rule of 72”. This rule is another estimating method to determine how long it will take for your money to double. The principal understanding is to take 72 and divide it by the expected return of your investments. For example, if you expect an overall return of 7.2% per year, 72 / 7.2 = 10. 10 years. 10 years it would take for your investments to double. WOW! That’s honestly not that bad.
Let’s expand this a bit further, using the simple math above if your annualized return on investment is 8%, then 72 / 8 = 9. 9 Years for your money to double if your investments return 8% per year. That’s awesome. Great, so if we keep a set increase of 7.2% returns (remember, easy math here), after 10 years, an initial investment of $10,000 will double to $20,000. Keep going… $40,000… $80,000 after 30 years. Now, none of this math accounts for employer contributions to a 401(k), nor does it account for the rate of inflation. Historically, the market continues to go up, even with massive recessions (think: investments on sale, buy more!)
These estimates work for other examples too, feel free to plug in your own numbers and estimate how few years it’ll take to get to where you want.
So What Can You (an Investor) Do?
Focus on the long-term: Yes, the market will drop, daily. However, historically, the market bounces back and continues to make higher highs and higher lows. Investors typically don’t lose a significant portion of their investments because of what they have invested in… but because of how they have reacted to these drops in the market. Pulling money out and selling investments when the value of your investments has dropped is a sure way to solidify your losses. Be strong and ride out the market fluctuations. (NOTE: you generally want to avoid investing in individual companies so as to limit your individual portfolio risk; focus on ETF’s/Index funds as they invest in many companies all at once)
Stay Disciplined: Throughout your life, as you make major changes to your budget, your income, your family, you must remember that in order to set yourself and your family up for success in financial independence and the ability to retire (early), you MUST stay disciplined. You must continue contributing towards your goals and stay focused.
Use the market dips to your advantage: Remember earlier I was mentioning that the market drops, daily? Well, I also mentioned that you can take advantage of these market dips by purchasing investments when the markets are down. So how do you do this without completely losing it all? Well, I recommend that you set up automated investments into whichever portfolio you are trying to grow. This could be automatic contributions to your 401(k) with any company match or could be $500 a month towards a Roth IRA with automatic reinvestments enabled. Either way, you’re going to continue investing and remove the emotional aspect of investing.
Closing: Remember Your Purpose For Investing
I understand that it is extremely difficult to remove the emotional side of investing and seeing the market go red (down) for multiple days or weeks or months on end is hard. You have to remember why you are investing. You must continue to contribute towards your investments and not try to stop investments or to change your investments just because you believe that they are better suited elsewhere. Remember that you are investing to reach your financial goals.