Before figuring out how to invest money wisely, it’s important to first remove financial costs that are holding you back.
It is generally best to get rid of high-interest rate charges, lower your taxes and build up a rainy day fund before investing in the stock market.
But what is the first step in maximizing your nest-egg savings and what are the ways to make money investing in the stock market that few people know about?
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Table of Contents
Pay Down Debt
Before investing in the stock market, pay down debt that has a high interest rate.
If you are like most people, some portion of your monthly earnings are allocated to paying principal and interest on at least one loan.
Perhaps it’s a student loan or a mortgage or a car loan or a credit card payment that needs to be made.
No matter what it is, examine the interest rate you owe before taking the plunge to invest in the stock market.
If you are paying an interest rate of 10% on a loan but earning 8% in the stock market, you are worse off investing than paying down debt.
It’s nice to see a brokerage statement return profits at the end of the year, but don’t be fooled by those earnings. If your interest payments were costing you more than your rate of return, investing isn’t a game you want to play just yet.
Smart money management starts with paying off debt intelligently. Sometimes it makes sense to both invest and pay down debt simultaneously.
For example, you might enjoy tax-breaks on interest mortgage payments so a portion of the upfront payments are credited back to you around tax time. Or maybe you are paying a very low interest rate on a student loan. But more times than not – unless you can earn more by investing than what you are paying in interest on debt – it is better to first pay down debt.
Build Your Savings Nest-Egg
Once you have paid down high-interest debt, look to build up a cash savings nest-egg that can act as your rainy day fund.
For most individuals, building a savings nest-egg is the smartest next step after paying down high-interest rate debt. A rainy day fund gives you the peace of mind that you can dip into savings whenever you need cash most.
In an ideal world, you could jump straight from paying down debt to investing. But the moment you invest in the stock market, you take on some risk.
If the stock market has reached a plateau following the tail end of an economic cycle, the risk of a stock market correction might be higher than normal.
The last thing you want is to invest your savings into the stock market just at the moment when it is on the verge of falling.
Yet timing the market is notoriously difficult. Even professionals who are paid huge sums of money find it challenging to beat the market.
In fact, it is so difficult to outperform the market that Warren Buffett famously bet professional hedge fund managers that over a 10 year period they would not beat the S&P 500, and he won!
If the so-called smartest investors in the world find it hard to beat the market, then casual investors should tread carefully before trying to do so. Classic investing approaches shared below are a much better bet for most.
Once you have built up cash savings, you can look to allocate money to various buckets. For example, some roboadvisors, such as Betterment, offer customers a way to allocate money to buckets that are invested to reach financial goals. You might be saving for a new home, a new car, a wedding or a vacation.
Allocating money to various financial buckets is a smart way to save, but before you grow any of these buckets, first grow your savings nest-egg so your rainy day fund is never in jeopardy.
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Lower Your Income Taxes
When you are ready to invest, choose tax-deferred retirement accounts so that your earnings can grow tax free until withdrawals are taken in retirement years.
With high-interest rate debt paid down and a cash savings or a rainy day fund in place that you can dip into in case of emergencies, you can feel more confident to invest in the stock market.
The first dollars you invest in the stock market should be aimed at lowering your taxes. And one of the best ways to lower your taxes when investing in the stock market is to allocate money to a tax-deferred retirement account, such as an IRA or 401(k).
For example, an employee investing $10,000 into a 401(k) account will enjoy a tax-shield of $10,000 on contributions. That means if the employee earns $100,000 annually, only $90,000 of income is taxable.
Taxes are deferred until retirement years, allowing earnings grow tax-free in the interim.
Choose Index Funds
Index exchange-traded funds have low fees compared to actively managed mutual funds.
The Vanguard Total Index fund, ticker symbol VTI, is one of the highest rated index funds available to retail investors. One reason it wins high marks is its fees are low. But how important are fees really when it comes to investing?
A small difference in fees can add up over time way more than most investors can imagine.
A casual investor might think that an extra 0.5% annually is no big deal. After all, if your portfolio was growing 7-8% a year, paying 0.5% in fees doesn’t seem too costly. But over time, it becomes very expensive due to the hidden power of compounding.
To highlight the negative effect of fees on portfolio growth, compare the costs of mutual funds to those of exchange-traded funds.
Actively managed mutual funds generally have higher fee schedules than passively managed exchange-traded funds.
The expense ratios incurred by mutual fund holders can be 2x, 3x, 4x or more what ETF shareholders pay.
And the power of compound interest transforms what seems like a small differential each year into a huge sum of money over the span of 30 years.
Over that time frame, here is the difference in portfolio growth when $100,000 is invested.
|Year||Annual Gain (8%)||0.50%||1.00%||1.50%||2.00%|
You can see that over a 30 year time horizon, an investor paying fees of 0.50% annually saves approximately $300,000 more than an investor paying fees of 2.0%!
Robo Advisor Investing
Roboadvisors generally charge low management fees, use low-cost ETFs, and many offer free automated rebalancing and tax-loss harvesting services to maximize after-tax returns.
If you are trying to figure out how to invest money wisely, you can save yourself a lot of hassle by selecting a robo-advisor who does the hard work for you.
Some of the leading robo-advisors, such as Betterment and Wealthfront, came on the scene back in 2008. They have become so successful since then that they have gathered billions of dollars in managed assets.
The value robo-advisors offer is compelling to the casual investor because:
- Portfolio management fees are comparatively low;
- Expense ratios are low because low-fee ETFs are generally used;
- Portfolio management is automated so you can be hands-off;
- Tax-loss harvesting is employed (by many robo-advisors) to maximize after-tax returns;
- Automatic portfolio rebalancing is widely used to prevent portfolio drift so no single position has too much weight in a portfolio;
- Hybrid robo-advisor solutions are increasingly popular; this is where human advice is combined with technology-powered portfolio management;
- Competition is increasing among robo-advisors, so costs are low – so much so, Schwab even has a zero management fee offering via its robo-advisor, Schwab Intelligent Portfolios.
Some robo-advisors, such as Hedgeable, even offer a twist on the standard money management approach. Hedgeable strives to limit downside risk during market declines.
The biggest value-add robo-advisors offer is lower fees compared to most traditional financial advisors, who often charge north of 1% in management fees annually.
When you compare to robo-advisors, such as Betterment, which charges just 0.25% for its basic offering, Betterment Digital, the savings are substantial over time.
For hands-off investors who want to outsource the responsibilities of money management to a financial advisor, but don’t want to pay the higher fees associated with human financial advisors, low-cost robo-advisors are a great investing alternative.
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Invest in Value Stocks
Value stocks are favored by many of the wealthiest investors in the world because they have high upside and limited downside risk. Often, they pay stable dividends, have growing earnings, and fair values much greater than their current share prices.
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As a self-directed investor, you will need to do a little homework before pulling the trigger and buying stocks.
Start by examining the best value stocks. These are stocks that may be out of favor currently but have intrinsic values greater than their market capitalizations.
Value stocks are favored by some of the wealthiest investors in the world because the downside risk is limited due to strong underlying factors, such as:
- Stable dividends;
- Predictable, growing earnings;
- Low default risk;
- High levels of cash on the balance sheet;
- Fair value greater than current price
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Make Money With Options
Covered Calls and married puts are among the best options trading strategies to produce income and limit downside portfolio risk.
Buy-and-hold investing has its merits, but did you know that you don’t have to rely on quarterly dividends issued by a company to get paid an income from stocks you own?
Self-directed traders who are keen to produce additional income should explore one of the best options trading strategies: the covered call.
When you own a stock, you can sell a call option to produce a fixed income amount. For example, you could decide that over the next week, month, quarter or even year that you want to get paid an income from your shareholding.
Covered calls allow you to generate additional cash flow from stocks you already own. So what’s the catch?
When you sell call options against shares you own, you are entering a contract whereby you agree to sell your stock at a fixed price over a specific time period.
For most investors trying to figure out how to invest money wisely, the covered call is an excellent strategy, but you can use options to achieve other financial goals too.
When markets fall, it’s easy to become fearful. Wise investors have legendary quotes about how to take advantage of market sentiment when it reaches extremes.
Warren Buffett’s quote be fearful when others are greedy and be greedy when others are fearful sums up rational decision-making needed to win long-term.
But staying rational when markets are falling is easier said than done. And that’s where options can play a role in your investing approach.
When you own stocks and wish to limit portfolio risk, you can buy protective put options that act as a hedge in case your stocks fall in price. The combination of owning stocks and buying puts is called a married put strategy.
Like any insurance you might buy, stock insurance in the form of protective puts requires you to dip into your pockets and pay a sum of money for peace of mind. But it can be cheap when considering the alternative of simply owning stock.
For example, if a $50 stock were to fall to $30, you would lose $20 per share if you had no protective puts in place.
If you were to purchase a put option at strike 50, you would have to pony up some money to buy the insurance, but if the stock were to fall below $50 you would have the right to sell the stock at $50 per share – no matter how low the stock fell.
This peace of mind can make it a lot easier for you to act rationally as Warren Buffett and other wealthy investors advocate, so that you capitalize from market sentiment rather than succumb to it.
Have you got other tips on how to invest money wisely? Share them in the comments below.
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