Laying a strong foundation before investing in stocks and shares.
Stocks and shares for the long run
Stocks and shares should form a significant proportion of the portfolio of the long term investor.
The evidence for the out-performance of stocks and shares over bonds and cash in the long term is well established – read my blog.
Before you invest.....
Before investing in the stock market, there are fundamental steps you should take to establish a solid personal and financial foundation.
I have listed 10 of them below.
1. ESTABLISH YOUR FINANCIAL GOALS
- What are your financial goals?
- Are your goals short term or long term?
- If your goals are short term like saving for a holiday, buying a car or a house, then save in an accessible cash account.
- If however you have long term goals of over 5 years, then consider the stock market either through individual stocks and shares or investment funds.
- Long term goals include saving into a pension plan, buying a second home or saving for university/college fees.
2. BUILD CASH RESERVES
- Financial emergencies are inevitable in life – for example replacing a faulty washing machine, car repairs,
- Therefore before you start investing, build up cash savings.
- This will prevent you selling your investments to meet these unexpected needs.
- Build up an emergency fund equivalent to 6-8 months of your expenses.
- Many USA households have less than $1000 in savings.
- A UK survey of 1000 households showed 20% had no savings. 12% had savings of less than £250. There are over 8 million people in this position.
3. MONITOR YOUR PERSONAL EXPENSES
- Keep track of your personal expenses.
- Review your expenses regularly to see where you can make savings.
- Do you need to buy that expensive cup of coffee daily?
- Can you make your own packed lunch instead of buying the expensive sandwich at work?
- Invest your savings!!
- Use a Personal Expenses Template like the Google template.
4. LEARN TO SAVE AND INVEST
- Spend less than you earn.
- Avoid “Lifestyle Creep” – increasing your standard of living in order to match your increased income.
- Develop the habit of delayed gratification.
- Aim for financial independence & security.
- Save at least 10% of your income. The average is currently only 1.7%
- Save regularly. Set up automatic monthly transfer from your checking or current account into your savings account.
- Start investing early to employ the power of compounding.
- “Those who understand compound interest earn it and those who don’t pay it”.
5. CALCULATE YOUR NET WORTH
- Establish a personal balance sheet.
- Calculate all your assets and liabilities .
- Establish your financial or economic net worth.
- Increase your net worth by either increasing your assets and income or by reducing your liabilities.
- Aim to move from a position of negative net worth to zero and into positive wealth.
- Link to Google template.
6. PAY OFF YOUR DEBT
- Do you have debts on store cards, credit cards, loans and overdrafts?
- Do you know how much interest payments you make monthly?
- How much leverage and debt does your household have?
- Reduce your liabilities by paying off your debt.
- Move into positive wealth.
7. BUY LIFE INSURANCE
- Protect yourself and your family from unexpected loss of income from serious illness, injury, disability or death.
- Determine your financial risks from loss of income and insure to cover them – for example children’s education costs.
- A Family Income Benefit policy pays a monthly income.
- Some policies pay a lump sum.
- A Life Insurance policy is a very crucial component of financial planning!
8. BUY A HOUSE
- A house is probably the most prudent investment most people will make.
- Consider saving to purchase a house before investing in the stock market.
- A mortgage provides significant leverage. For example, if the price of a property on which you put down a 15% deposit increases in value by 5%, the return on your investment is 33%.
- Human behaviour means houses are bought as a long-term investment and can generate appreciable wealth.
9. KNOW YOUR RISK TOLERANCE
- Be aware of yourself, your attitude to risk and your psychology.
- If you prefer low risk investments then save in a cash account.
- Stocks and shares outperform cash in the long term. In the short term they can be volatile and you may lose money.
- To invest in stocks and shares, you should have a horizon of more than 5 years.
- Do not invest money you are likely to need at short notice.
- You need PATIENCE, to be a successful investor.
10. LEARN HOW TO INVEST
- Read, read and read!!
- Learn how to read and understand company financial accounts, financial numbers and ratios.
- Learn how to evaluate and screen individual companies for investment.
- Learn how to write a one-page investment thesis for each stock you buy – read my blog on how to write an investment thesis.
- Master the principles and processes behind building a long-term portfolio of stocks and shares.
- My book, “The Smart & Common Sense Investor”, is a constellation of the principles of long term investment in stocks and shares.
- The principles of long term investment are simple but require hard work and dedication to master.
- Invest in yourself to learn and understand them.
