Learning to invest isn’t as difficult as it seems. Really, it’s true. But you have to decide where to start and when to start first. Investment 101 is a guide for anyone who wants to start investing for their future.


Some people in the financial services industry may want you to think investing is rocket science, but I disagree. I believe this is not rocket science, and I have a formula that I want to show you to back that up. I call it Investment 101.

I know the world of finance and investing is full a ton of confusing words, but if you understand the concepts behind investing and growing your money, you’ll be well on your way to being the artist behind it.

So where should you start?

The first thing I recommend to anyone who’s interested in investing their money is to determine whether or not you can afford to invest.

Obviously, if you have some money saved you can afford to put it somewhere for investing, but that’s not really what I’m talking about.

Ask yourself “What if my investment were to perform poorly and lose all of its value?” Would this be a problem, or would you have other money saved to cover you in the case of an emergency?

 I believe success in investing is all about sticking to fundamentals

So, start by examining your most basic, plain-vanilla investment, your emergency fund.

I’m a firm believer in saving for a rainy-day emergency and investing as well, but I’ve seen people confuse the two. Investment 101 says it’s important to keep the two seperate.

Investment 101 Tip: Your Emergency Fund Is for Saving, Not for Investing!

Speaking from experience, it’s never a good idea to invest your emergency fund into anything that can fluctuate in value because if your emergency fund loses value before you even pull any money out, imagine what taking even more out would do to it…

Yes, it may be attractive to grow your emergency fund by buying a mutual fund or a stock, even if the market’s doing great, but the market doesn’t always do great, sometimes it does downright horrible.

Let me tell you a story about a young man who thought it would be a good idea to invest his emergency fund into a self-directed brokerage portfolio, because he thought he was smart about investing. It turns out he wasn’t that smart, because shortly after he put his money into some ETF funds that looked good, the market started to dip and before he knew it, he had lost about 20% of the money he had put in.

Yes, I was that guy and my girlfriend at the time who’s now my wife was not happy about it.

The moral of the story is money that you may need for an emergency needs to be kept somewhere safe, liquid and secure.

Before you start investing, my advice is to have 3 to 6 months’ worth of emergency expenses (not your income, just what it costs you to live) in a bank checking or savings account if you have a secure job and you feel you have a high likelihood of keeping that job for at least the next five years.

For those who earn commissions or whose pay comes sporadically, I recommend saving anywhere between 6 to 12 months’ worth of your expenses in case things slow down at work and you need to bridge the gap for a few months.

I always recommend having that emergency fund fully funded before you invest. Here’s why…

  1. For starters, it’s usually a lot easier to take money out of a bank checking or savings account than it is to pull money out of a brokerage account, retirement account or employer sponsored plan like a 401(k), you write a check or use your debit card.
  2. Second, there can potentially be taxes or penalties associated with taking your money out of certain accounts early (like a 10% penalty for taking money out of a traditional IRA account prior to age 59 ½).
  3. And third, like we just discussed, if you sustain losses in your account due to stock market volatility, you’ve taken an unnecessary risk with your emergency fund.

In my opinion, your emergency fund should be kept completely separate from any investment funds you have and should only be touched in case of a legitimate emergency such as a home repair, medical bill, an unexpected tax bill or pretty much anything else that is unexpected and urgent.

What about saving in my 401(k)? They give me a match at work and I want to take advantage of it but I don’t have 3 to 6 months’ worth of emergency expenses saved, should I do it?

This is a tough one, I definitely think you’d be a lot better off having a fully stocked emergency fund prior to investing in a 401(k), but that match can be a very attractive offer because it’s extra money that your employer puts away for future, some people even consider their match as “free money”.

It really depends on your personal preference, if you feel compelled to stash away money for your future before having a fully stocked emergency fund, my advice would be to make sure that you are debt-free besides a mortgage before doing so. Consider saving enough to maximize the match your employer is providing and directing the rest into a liquid emergency checking or savings account.


OK, emergency fund. Check. What’s next?

Now that you have enough money saved to cover you in case any emergencies happen, you’ve got options…

Where you go next really depends on what’s important to you. My advice is to save for retirement, but if you have a fully stocked emergency fund and you’re interested in making a large purchase instead, now may be a time to start saving for it.

I do definitely recommend, however, maxing out your 401(k) to your employer match (if available) first before saving for that large ticket item. I cover saving for large purchases in another section on my site so I’m not going to spend too much time on it here but I will say this, be careful about taking too much risk in saving for large purchases.

It can be very appealing to know that you have the chance to get to your dream wedding faster by taking advantage of upswings in the stock market, but I look at savings for large purchases as having similar DNA to saving for emergencies.

Both types of money should be saved where you can get on it quickly. Liquidity is important, although, not quite as important for large purchases as it is for emergencies. But obviously, paying for a large purchase out of an account that has liquidity issues at the time you need to take the money out is definitely not a very smart move especially since it can be avoided.

How much time do you have before you need to make that purchase? When’s the wedding? When are you planning on buying that new car or home?

If you’ve got five or 10 years to spare before you buy, you may be able to stomach a little bit of volatility but it would certainly be a shame to see you save for a large purchase only to lose more money than you gain along the way.

The point is, I would be just as disappointed if I lost 20% of my vacation fund as I would be if I lost 20% of my emergency fund. I still believe, after looking at thousands of potential investments over my career, that a good savings account is just about the best place you can stash money away for your next big purchase.


Next stop, Retirement

Although it may be tempting to start saving for more short-term financial goals after funding your emergency fund and before funding your retirement, Investment 101 recommends saving for retirement next instead.

We’re talking about your future here, and if you don’t start saving for it, no one will. 

The good news is, you don’t have to take ALL the extra money you have laying around and save it for the distant future.

If we did that, we may have an emergency fund, and we may have retirement savings, but we wouldn’t have money for anything in between like saving for a down payment on a house, buying a new car or that wedding we were talking about a little earlier, pricey stuff

OK, so I need to save for retirement but I’m not supposed to save all my extra money there, how much should I save then? I recommend saving at least 15% of your gross income (your before-tax income) for your retirement.

Example: if you make $100,000 a year then you should save at least $15,000 of that money for your retirement on an annual basis as well.

If you can save 15%, and you’re disciplined about it, you should be able to accumulate a good amount of savings for retirement by the time you decide to stop working.

Of course, if you have plans to retire early or if you don’t have a lot saved and you’re just getting started saving close to your desired retirement age, you will definitely need to save more than 15% of your income, but as a general rule, I say start at 15%.


So where are the best places to save for retirement?

For ease-of-use, convenience, and added perks (like an employee match if available), I usually recommend people look to their 401(k) plan at work first to start investing for their retirement.

A 401(k): This is what we call an employer-sponsored retirement plan. I say a 401(k) is easy-to-use and convenient because your contributions to a 401(k) are usually payroll deducted, meaning that a percentage of your income is taken out of your paycheck and put into your 401(k) account automatically for you.

Automatic savings is something I’m a big fan of. This way, you’ll always be adding money to your 401(k) and don’t have to worry about actually putting the money in the account, that’s all taken care of for you automatically. The only thing you need to in your 401(k) do is authorize how much they take out and you don’t need to change anything unless you decide to save more or less money or change your investment options.

Depending on the flexibility of your 401(k) plan, there may be multiple funds, stocks or strategies available to choose from when deciding which types of investments you utilize. I cover different types of investments in Finding the Best Place to Save for Retirement.

An IRA: there are two different types of IRAs, the traditional IRA and the Roth IRA.

Although both of these accounts are classified as IRAs, they have some notable differences involving the way your money is taxed. There are several factors to consider when deciding whether you should choose a traditional or Roth IRA based on those differences in regards to taxes.

To make it simple, the income you move into a traditional IRA is tax-deductible and grows tax-deferred until you decide to take it out.

The Roth IRA, however, is funded with money that has already been taxed, so as you invest your Roth IRA funds for the future, your money will grow tax-free and you do not have to pay income taxes when you take the money out.

In most cases, you are free to contribute to a 401(k) at work and also an IRA or a Roth IRA but there are income limits to being able to contribute to a Roth, so if you make a higher income, you may actually make too much to contribute to one.

If you earn too much to contribute to a Roth, you can still contribute to a traditional IRA because the traditional IRA does not have an income threshold.

Personally, I’m partial to the Roth IRA because there’s always uncertainty about what taxes will look like in the future. I would rather pay tax on a small amount of money right now at a tax rate that’s known than leave my future taxes up to whatever the rates look like when it’s time for me to take that money out later.

Another reason I’m a fan of the Roth is that since you fund it with after-tax money, you can actually take your contributions (not your gains) out of the Roth before age 59 1/2 and you won’t have to pay taxes or a 10% penalty to the IRS like you would if you took your money out of a traditional IRA.

Some employers, depending on the type of plan they have, will allow for Roth 401(k) contributions.

This could be a good strategy for those that are interested in a Roth but may make an income that is too high to contribute to a Roth IRA.

  • Both a 401(k) and a Roth 401(k) have contribution limits of up to $18,000 per year (in 2017) up to age 50 (not including your employer’s match)
  • Or as high as $24,000 a year (not including your employer’s match) if you’re 50 or older.

For those that make a higher income, a traditional or Roth 401(k) will allow you to make a larger contribution annually than an IRA will. IRA contributions max out at $5500 per year in 2016 for those who are below the age of 50 and $6500 per year for those 50 or older.


Next, comes short-term & medium-term savings

Now that you’re all set up and prepared for emergency expenses with at least 15% of your income going towards saving for retirement, Investment 101 says you can look at filling in the gap with some short-term to medium-term savings.

Although your emergency fund would be considered short-term savings, short and medium-term savings are a little different.

I consider short and medium-term savings to be the money you’re putting away now that you’re planning on spending over the next 3 to 10 years or longer.

Short-term and Medium-term savings are not the same as large purchases either unless that large purchase is being made several years down the road. This short-term and medium-term money could be money that you’re planning on spending later on things like college savings, or money that you’re planning on using to supplement your retirement.

How much risk should you take with your short-term to medium-term savings? Can I invest those in the market, or would I be better off keeping that money in the bank? This really depends on how you feel about the risk, I know some people that are not okay with losing a penny of their hard-earned money in the stock market. If that sounds like you I would lean more towards investments that have guarantees like bank savings.

But if you feel good about your emergency savings and you feel like you’re on track with your retirement savings and you’re just looking to grow your money, the market may be a viable option for you over the next 3 to 10 years.

What types of investments are commonly used for short-term and medium-term savings?

I go a little bit more in-depth on the best types of places to save in another section of The Art of a Plan, but there are several different options available for those looking to invest over the next 3 to 10 years.

Investment 101 says a few common places that investors choose to save for a short or medium-term are;

Brokerage Accounts: A brokerage account can either be self-directed (meaning you purchase and manage the investments yourself) or you can hire a financial advisor or broker to help manage the account for you.

Inside most brokerage accounts, you have the option of literally tens of thousands of different stocks, bonds, mutual funds, commodities and more at your disposal. If you consider yourself a savvy investor and have a good idea of the types of investments you want to use then a self-directed brokerage account could be a good place for you to get access to those investments without having to pay a financial advisor to help you manage them.

You can always hire a financial advisor to help you invest or even create a custom portfolio for you if you don’t mind spending a little of your cash on management fees, financial planning or commissions. Your fees and any commissions paid depend on what type of advisor you choose.

Tax-Deferred Investments like Annuities or Cash Value Life Insurance: Although annuities and cash value life insurance can be a little bit difficult to understand, one advantage that they have is that any gains from investment growth inside of that annuity or life policy are tax-deferred and sometimes income-tax free.

This means that if you have investment growth inside of your annuity or life insurance contract, you don’t have to pay taxes on those gains until you take the money out. And in the case of a life insurance policy, the cash value can also be passed along to your beneficiaries income tax-free upon your death.

A word of caution, though, annuities are not meant to be short-term vehicles, most annuities require that you keep your money there for 5 to 10 years. If you take your money out sooner, you could be subject to penalties or surrender charges.

There are some features which allow you to take some of your money out of an annuity early without paying surrender charges, but taking a large percentage of that money out too early could result in fees.

When you have to pay money just to take your money out, that can cut into your investment gains, and this is not a good thing. For anyone looking to purchase an annuity for a short to medium-term investment horizon, I urge you to read the fine print, understand liquidity features, and understand exactly what will happen if you need to take your money out early prior to making the decision to purchase an annuity contract.

Cash value life insurance is also a long-term investment that could potentially be a good supplemental savings vehicle if you’re fully funding your IRA or 401(k) accounts and are looking for additional tax-deferred growth potential.

Cash value life insurance is sometimes sold as a stand-alone solution for retirement, but I disagree with this idea and feel like if you don’t have a legitimate need for a death benefit, the cost of cash value life insurance can definitely outweigh its advantages unless you’ve just run out of other places to stash your extra cash.

If you’re okay with a lack of liquidity or have definite plans to take your money out at a specific time that would not result in you paying more than you want to in penalties or surrender charges, an annuity or cash value life insurance policy could be a good choice for a medium-term investment. But in my experience, most annuities and cash value life policies are not a good fit for short-term (1 to 5 year) time horizons.

It pays to have a plan

We just talked a lot about different places that you can save and different ideas behind how much you should save, but I didn’t really talk about risk very much at all.

It’s extremely important to make sure that the investments you make in the market are in line with how much risk you are actually comfortable in taking with that money.

It’s also important to understand that different types of investments carry different types of risk.

I like to use the Risk Rainbow™ to help me determine which types of investments may be a good fit for my clients, this is an idea I believe everybody should use at one point or another. Learn more about the Risk Rainbow™ here.

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Good Planning, Good Saving and Good Investing!

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