The Key to Consistent Investing? Pay Yourself First
Consistency is a key ingredient of success in many activities – including investing. And one technique that can help you become a more consistent investor is paying yourself first.
Many people have the best of intentions when it comes to investing. They know how important is it to put money away for long-term goals, especially the goal of a comfortable retirement. Yet they may only invest sporadically. Why? Because they wait until they’ve taken care of all the bills – mortgage, utilities, car payments and so
on – before they feel comfortable enough to write a check for their investments. And by the time they reach that point, they might even decide there’s something more fun to do with what’s left of their money.
How can you avoid falling into this habit of intermittent investing? By paying yourself first. Each month, have your bank move money from your checking or savings account into the investments of your choice. By taking this hassle-free approach, rather than counting on your ability to send a check, you can help ensure you actually do contribute to your investments, month after month.
By moving the money automatically, you probably won't miss it, and, like most people who follow this technique, you will find ways to economize, as needed, to make up for whatever you're investing.
You already may be doing something quite similar if you have a 401(k) or other retirement plan at work. You choose a percentage of your earnings to go into your plan, and the money is taken out of your paycheck. (And if you’re fortunate, your employer will match some of your contributions, too.)
But even if you do have a 401(k), you’re probably also eligible to contribute to an IRA – which is a great vehicle for your pay-yourself-first strategy. You can put in up to $5,500 per year to a traditional or Roth IRA (or $6,500 if you’re 50 or older), so, if you are able to “max out” for the year, you could simply divide $5,500 or $6,500 by 12 and have either $458 or $541 moved from your savings or checking account each month into your IRA. Of course, you don’t have to put in the full $5,500 or $6,500 each year, although some IRAs do require minimum amounts to at least open the account.
You might think such modest amounts won’t add up to a lot, but after a few years, you could be surprised at how much you’ve accumulated. Plus, you may not always be limited to contributing relatively small sums, because as your career advances, your earnings may increase significantly, allowing you to boost your IRA contributions continually.
In any case, here’s the key point: when you invest, it’s all right to start small – as long as you keep at it. And the best way to ensure you continue investing regularly is to pay yourself first. If you do it long enough, it will become routine – and it will be one habit you won’t want to break.
What about Risk Tolerance???
To succeed as an investor, you might think you need to know about the economy, interest rates and the fundamentals of companies in which you’d like to invest. And all these things are indeed important. But it’s most essential to know yourself. Specifically, you need to know how much risk you are willing to tolerate to achieve your goals.
Of course, you’ve lived with yourself your entire life, so you probably have a pretty good idea of your likes
and dislikes and what makes you comfortable or uncomfortable. But investing can be a different story.
Initially, you may believe you have a high tolerance for risk, but if the financial markets drop sharply, and you see that you’ve sustained some sizable losses (at least on paper – you haven’t really “lost” anything until you sell investments for less than what you paid for them), how will you feel? If you find yourself constantly fretting over these losses, perhaps even losing sleep over them, you might realize your risk tolerance is not as high as you thought. In this case, you may need to scale back the part of your portfolio devoted to growth in favor of a more balanced approach.
On the other hand, if you believe yourself to have a low risk tolerance, and you start off investing in a conservative manner, you may indeed minimize short-term losses – but you also might find yourself frustrated over the slow growth of your portfolio. So you may decide that being highly risk-averse carries its own risk – the risk of not making enough progress to achieve your long-term financial goals. To reduce this risk, you may need to tilt your portfolio somewhat toward more growth opportunities.
In short, you may have to invest for a while before you truly understand your response to risk. But even then, don’t get too locked in to one approach – becauseyour risk tolerance may evolve over time.
When you are first starting out in your career, and for many years after, you are probably investing primarily to accumulate assets for retirement. Consequently, you may need to include a relatively high proportion of growth-oriented vehicles, such as stocks, in your portfolio. While stock prices will always fluctuate, you will have many years, perhaps decades, to overcome short-term losses, so you can possibly afford to take on a greater risk level in exchange for the potentially higher returns offered by stocks and stock-based investments.
However, things can change once you reach retirement. At this stage of your life, your overall investment focus may shift from accumulation to income. This means you will need to start selling some investments to boost your cash flow – and you won’t want to sell when prices are down. (Remember the first rule of investing: “Buy low and sell high.”) To help avoid these “fire sales,” you may want to adjust your investment mix by adding more income-producing vehicles and reducing your holdings in growth-oriented ones. By doing so, you will be lowering your overall risk level. Keep in mind, though, that even in retirement, you will need some exposure to growth investments to help you stay ahead of inflation.
Become familiar with your own risk tolerance – it can play a big role in your investment decisions.
Jesse Abercrombie, Financial Advisor, with Edward Jones Investments has been an IEC member since 2004 and focuses his practice on the needs of family owned businesses inthe construction industry. For any questions, please contact him at (972) 239-0852 or firstname.lastname@example.org.