Monday, April 21, 2014

It may seem like common sense to put your investments in risky single stocks that could double overnight. It may seem smart and exciting to invest in your best friend’s new lawn care business. It may even seem like an amazing opportunity to give all your money to charities and do some extraordinary giving. However, the number one step that people forget in making these major financial decisions is having a plan.

Having a plan means understanding fully where all your money is going. For instance, if you were to put all your potential retirement savings in a single stock, you might wake up one morning with no savings left after that company bottoms out. Single stocks are an unwise use of non-disposable money. The only way I would recommend investing in single stocks is if you wanted to do it with extra money lying around or if you do it as a business. Warren Buffett often preaches that you should not invest in companies or ideas that you do not understand. So, if you are in the business of learning about companies, becoming involved in them, and you are in a place where you can pay for it with cash, then maybe investing in single companies will be beneficial. In general, though, the best thing to be with your money is boring! If you want to invest and save, you should consider being patient. Investing long term means checking out the history of the index funds, watching the market average 8-12% over the past century, and finding mutual funds that will help you stay ahead of the curve.

In investing for retirement or for later in life, there are a few things to consider. First, be aware that tax sheltered and deferred options are going to give you the most return on the money you put in. Look in to Roth IRAs and traditional IRAs and other such agreements. Also, be aware that mutual funds are not all the same. Find one that is going to average 8-12% per year. If you do not, you will barely be keeping up with inflation (1-4% a year) and you won’t see significant growth.

Now, in talking about risky saving, I would like to warn you about borrowing from your 401K. Generally, when you borrow from your 401K, you can pay yourself back with interest, meaning that you are just saving more money as you funnel it back into the 401K. However, you are forgetting the most important factor in money: risk. This is the same as investing in single stocks. Imagine that one day you wake up and you find out that you have to leave the company you have invested your 401K into. This will happen at some point. You will either find a better job, be fired, or pass away. At that point, you will have 90 days to repay the loan or it will be considered an early withdrawal. You will be taxed an enormous percentage, and you will lose a lot of money.

In thinking about long term investing, do not be risky or try to be clever. Be boring, wise, and slow. Get your money in good mutual funds that will have a high yield over a long period of time. Do not borrow from your 401K. Always look for ways to circumvent taxes and get the most bang for your buck!