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How to Start Investing
The 5 Point Framework
In last weeks edition which can be found here, I detailed my story and how I decided to begin my investing journey. Some of you might now be thinking “OK, that made sense. I want to start investing. Now what? How do I actually start investing”. This week I detail a 5 Point Framework that could be used to start investing. For current investors, this framework can also serve a role in validating whether your actions to date are consistent with your long term goals or if changes are required.
1. Establish Goals
Establish what you want to achieve from investing. Your investment goals should be SMART. Below is an illustrative example:
Specific: I want to retire early.
Measurable: I will require an investment portfolio to the value of at least €500,000.
Achievable: Yes if I contribute ~€800 per month assuming an 8% return per annum after. Investment calculator is a great tool to play around with to get a sense of the correlation between contribution, expected return and time.
Relevant: This is what I want and is not the goal of somebody else.
Time-based: I am giving myself 20 years.
Your goal can be as big or as small as you like. Maybe you want to have enough money to buy a house or perhaps you want to have funds available to put your children through university. It’s entirely up to you.
The great thing about investing is that you can invest as little or as much as you want.
2. Prepare a Budget
A key driver in establishing your goals will be how much money you will be able to contribute to the goal. In order to determine this, you first need to understand where your money is going each month. Tracking your spending for a full month is a great way of doing this. There are a number of free templates within Microsoft Excel that can be accessed here.
The budget should contain all of the income you receive for the month minus all of your expenses or outgoings. The amount left over can be classified as savings. When performing this exercise for the first time you might be surprised to learn where some of your money is going. After analysing your monthly spending habits you will have a better sense of how much money you can contribute to investing.
Get into the habit of paying yourself first. When you get paid each month, move the money you committed to savings, then spend what is left over. The money that is put away into savings is the real amount of money that you have earned that month. Everything else just goes into someone else’s pocket, never to be seen again.
3. Set up an Emergency Fund
Before putting your hard earned cash into the stock market, the next step is to set up an emergency fund. An emergency fund is a bank account with money set aside to cover large, unexpected expenses.
An emergency fund is really important because the first rule of compounding and long term investing is to never interrupt it unnecessarily. If all of your money is in the stock market and a large unexpected expense arrives this will mean that you will have to sell some of your investments to cover the costs. Depending on how the stock market is doing on that particular day, you may actually loose money by having a forced sale.
It is widely believed that an emergency fund should consist of between 3 and 6 months worth of living expenses. Deciding on the exact amount is completely up to each individual and personal circumstances, there is no right or wrong answer. For example, if I am in my early twenties with no mortgage or loans I might be happy to hold the minimum of 3 months worth of living expenses. However, if I am in my late thirties with a mortgage and young children I might feel more comfortable holding 6 months worth of expenses. Consider your own risk tolerance. If the thought of only having 3 months living expenses in a bank account would keep you up at night then maybe it’s not the best strategy for you.
Don’t have the cash available yet for a full emergency fund but still want to start investing right away? One way to navigate this is to contribute to both until you build up a full emergency fund. For example, each month you could put 80% of your savings into the emergency fund and the remaining 20% into investments. This is a great way to dip your toe in and build your confidence and experience. Skin in the game is the best way to learn.
Another important point is that it is not advisable to invest money that you will require in less than 5 years. For example, if you have a lump sum that you plan to use as a deposit for a mortgage next year, do not invest this money in the stock market as the time frame is too short. Never invest money that you can’t afford to lose.
4. Establish your Style
There are two distinct ways to invest money: active investing and passive investing. There are merits to both styles as long as you have a long-term mindset. Analysing your lifestyle, budget, risk tolerance, and interests is a good way to figure what is best for you.
Active investing means taking time to research investments yourself and establishing and maintaining your portfolio on your own. Essentially, active investing requires more work, more risk and more potential reward.
You do the investing yourself
Lots of research
Potential for life-changing returns
Passive investing is the equivalent of putting a plane an autopilot versus manually driving it. Passive investing involves putting your money into investment vehicles where someone else is doing the work so you don’t have to. Passive investors can expect more simplicity, more stability and more predictability.
Less time consuming
I have chosen the active investing route because I have a passion for studying and researching individual stocks, I am willing to put the time in because I view it as a hobby and I like being in control of my own finances. Decide what works best for you.
5. Open an Investment Account
In order to invest yourself, you will need to set up an online brokerage account. I personally use DEGIRO but some other options include Trading 212 and Interactive Brokers in Europe.
Some of the reasons why I like DEGIRO include:
One of the lowest fees on the market
Regulated by multiple top-tier regulators
Easy-to-use web and mobile platform
If you are interested in opening a DEGIRO account you can use my referral link and you will get €20 worth of fees reimbursed.
You have established your goals. You have prepared a budget. You have set up an emergency fund. You have established your investing style. You have opened an investment account. Congratulations, you have now earned the right to invest your hard earned cash and are on the path to owning your financial future.
Of course, you could start investing without doing any of the above. However, by following a plan you are greatly reducing the risk of undesired consequences.
Passive investors can consider investing in low cost index funds or Exchange Traded Funds (ETF). An ETF is a basket of securities that trade on an exchange. An example of an ETF is the Vangaurd S&P 500 which consists of 500 of the largest U.S. companies including Apple, Microsoft and Amazon. With an ETF, you essentially own a little bit of lots of different companies.
For active investors, the real fun begins in terms of researching and screening individual stocks. A big component of active investing involves building a knowledge base and utilising research tools, which will be the topic of next weeks edition. Hit the subscribe button below if you have not already done so in order to receive the latest content straight to your inbox each week. Please also consider sharing with a friend if you find the content useful.
Wolf of Harcourt Street
Disclaimer: I am not a financial adviser and I am not here to give specific financial advice. The opinions expressed are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The information is based on personal opinion and experience, it should not be considered professional financial investment advice. There is no substitute for doing your own due diligence and building your own conviction when it comes to investing.