6 Simple Steps to Investing

I constantly get asked questions about how I would invest or what my investment strategy is. My investment strategy isn't new. I stole, learned, imitated, and synthesized knowledge from others. This is a pretty straightforward process, and if you want to skip to the end of the article to just get the steps, you can. It won't hurt my feelings too much, but I will go on to explain each step in order and why I do this type of investing.

$1,000 emergency fund

Having a small emergency fund is the first step to investing and helping you keep from accruing debt when the inevitable emergency hits. This is table stakes. The biggest reason for having this buffer is to keep you from having to put another emergency on a credit card and going deeper into debt. If you don't have anything. Start small. Start with saving $10.00 a paycheck to build this, and over time this habit you form will compound just like your money does later in investing.

Invest up to company match.

This is where I diverge from some financial pundits. I believe you should invest in your company match as the second step. Here is why. You don't get a better return on your money than 100%. Mathematically speaking, even if (which hopefully not) you had to touch the money, you will still come out ahead with the 10% penalty on your money. You do have to pay attention to vesting periods. Retirement funds are also protected from creditors. Psychologically this can help you feel like you are at least putting some money towards retirement while you pay off your debt and fill out the rest of your emergency fund. I'll cover what type of funds I suggest you invest in later in the article.

Pay off high-interest debt.

Next, we get laser-focused on eradicating high-interest debt. Why do we do this? Why not just skip to investing? Three reasons.

1. You can't beat a guaranteed return on interest as the money you put on principal towards debt. It's tax-free too.
2. It free's up your cash flow as you pay it off. Allowing you cash flow a lot of "emergencies."
3. The psychological freedom you feel when you have that paid off.

In mental health arena you are three times more likely to have depression, anxiety, and stress from debt pressure. According to AIMS Public Health

Fully fund your emergency fund.

Most financial pundits agree you should have 3 - 6 months in your emergency fund once you have paid off your high-interest debt. Having a fully funded one is the same reason you start with $1,000.00. It is to create a buffer between you and life. And even more, it makes a pillow between your investments and life. While investing up to your company match, you no longer have to worry about potentially tapping it because you have some cash reserves. I like to use YNAB cause it makes it easy. I use sinking funds for home maintenance, car maintenance, and other nonrecurring expenses, and then I find with cash the next couple of months of all my costs which usually cover about six months of base expenses. I am big on the YNAB train. I wrote more about their book and software here.

Max out tax advantage accounts.

Oh, man! You've been waiting for this part. You are thinking, "Just tell me what to invest in already!!!". The good news is if you've followed my above steps and you work at a company that gives a match on their 401k (403B, TSP, etc.), you are already on your way to maxing out one of your tax advantage accounts. This step seems exciting because of all the acronyms, but I'm a pretty simple investor, and there are two types of accounts that I max out.

*Quick note this is based in the US. The principal is the same but the specifics I outline below are more for that base.

1. Roth IRA
2. 401k (or work retirement account)

As of writing this, the max on a Roth IRA is $6,500, and the maximum on a 401k is $22,500

Anyone earning an income can contribute to a Roth IRA, and most employers have a 401k or equivalent for you to contribute to. I put everything in my Roth IRA in VTSAX and use Vanguard. Why? Because JL Collins told me to in his book Simple Path to Wealth. Essentially I invest in a fund with a low expense ratio (.20%) or less and one that follows S&P 500, Total US Stock Market, Total World Stock Market, or a Target Date Retirement Fund.

For example, I can access S&P 500 fund FXAIX at my employer. The expense ratio is .02% (yes, you read that right). Through Vanguard, I invest in VTSAX, a Total US Stock Market Fund with an expense ratio of .04%.

If you want more details on why index funds are the way to go, I would read JL Collins's book or wait for my next article.

Invest in a taxable brokerage account, pay off low-interest debt, or consider expanding to real estate.

This is the the last step but before we get into the nuts and bolts of the step, if you have made it this far, congratulations! I'm not even this far yet. (although I skipped steps and do invest in real estate that's another article) Another thing, if you find you will hit your retirement goal by maxing out your tax advantage accounts, this step honestly isn't required. You may even consider using the margin in cash flow to enjoy life, travel, or give it away. Those are all very well options. If you need to invest to hit FI or you just want to invest a portion of your money then this is what I propose.

Honestly, all of the steps are "personal choice," just not my recommended method if you deviate from it, but in this step, it does become a personal choice when it comes to investing. I highlight three I would personally do, but here you have the margin to experiment and take chances.

Pay of low-Interest debt

The simplest of all the options is to put your money towards any other debt you have outstanding. This is honestly my personal favorite which is why it is first. The two most common low-interest debts you may have will be your mortgage and student loans. There are five reasons why I like this one best.

1. Simple
2. No tax liability
3. Guaranteed return
4. Immediate increase in cashflow once the debt is paid off
5. Psychologically is proven to be the best

I said before there are no correct answers for this step, but if there were one, it would be this one. Now I can hear the mathematicians in my head talk about the rate of return in the stock market, and usually, I would agree with you, especially in a tax advantage plan. But the simplicity of this step and the psychological benefit alone makes it the best choice for me.

Invest in a taxable brokerage account.

This is another simple option because it is like maxing out your tax advantage accounts, except now you just put it in a regular brokerage account but with the same index funds. Just because it is simple doesn't mean it isn't a great option. You still get the same type of return you would in a tax advantage account. You are just taxed on dividends, and if you trade (rebalance). If you put your stocks in an index fund, you typically avoid the taxes on trading since you don't do it. Dividends are taxed as "passive income," which has a significant tax rate of 20% or below.

Invest in real estate.

This is another excellent option. But it is the more complex option and takes the most learning. You would go and buy a single-family home (or some other form of real estate) and then rent it out or convert a house you've lived in into one. I put this last because it isn't for everyone, but if you learn it, you can make outsized returns with significant tax advantages. Real estate typically makes a 4% return yearly compared to the stock market, which makes 10% to 12%. We can even be conservative and say 8%, so investing in a taxable brokerage account seems like a no-brainer. But wait, there is more to the story. You can actually do things that give you an outsized return. I'll talk about three.

The first one is sweat equity. You can buy a house, fix it, and get an immediate upgrade in value and rental income. This could make this return outsized.

The second is depreciation. You get to claim depreciation as an expense annually for the most part. (Talk to your CPA for guidance) which reduces your tax liability. The catch-22 is when you are to sell it, your capital gains will be more, but there are ways around that if you decide to keep investing in real estate.

The third one, optional because of risk, is that if you borrow money (leverage), the actual return could be more than 4% on the actual cash you put in.

If you combine all three of these, that is where you sometimes see a 100% or more return on your money. You have to remember to factor in risk. Going into debt or leveraging always has some level of risk, and real estate is at the whims of your local area, which is also a risk. You aren't very diversified, but it has historically proven to be a great option, but many have failed at this path too.

Review

Below are the steps we talked through.

1. $1,000 emergency fund
2. Invest up to company match
3. Pay off high-interest debt (5% or more)
4. Emergency Fund 3-6 mos of base expenses
5. Max Invest in tax advantage accounts that are made up of low-cost index funds
6. Pay off low-interest debt, invest in real estate or a taxable brokerage account.

This is the optimal order I've chosen. I know there are other ways to invest, and this isn't the only way, but it is the simplest way I've found for me to invest.

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This article is informational; it should not be considered Health, Financial, or Legal Advice. Not all information will be accurate. Consult health, financial, or legal professional before making any significant decisions

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Updated on 11/1/23