How to Start Investing
The title to this post is admittedly a little misleading, but I still think is accurate for what I’m going to talk about. How to start investing is a broad idea, but I think the only appropriate way to start investing is to get your own finances in line. I wanted to get into investing my money as soon as I started making it, but I completely ignored the fact that I was paying tons of money out each month to various loans that I had. I, like many Americans, utilized credit that had been offered to me when I first graduated college. Heck, I even utilized credit to attend college!
Having access to loans is what, thankfully, allowed me to position myself in a good spot on the pathway to success. But like so many before and after me, the allure of getting something that I didn’t have the money saved up for at the time was too exciting to pass up. I came out of college with over $90k in student loans and do you know what the first thing I decided to do was? I got a credit card and bought myself a computer. Not just any computer, I built myself the coolest, flashiest gaming PC that I could. All in, even with being ‘smart’ about how I was buying the hardware, I spent almost $4,000 dollars on that machine.
What made this purchase even easier for me, was the fact that the credit card that I signed up for had a 0% interest period of 18 months. So if I wanted to, all I had to do was pay down that cost over the next 18 months and I wouldn’t be any worse off. That was easier said than done for me, I continued to put more and more purchases on my shiny new credit card, and continued to pay the minimum amounts, swiping more of my money away every day. When that 18 month grace period ended, my interest rate on my card shot up to just over 22%! Had I paid off the gaming computer and all the other cool things I bought myself over the past 18 months? Absolutely not.
The lesson to learn from that story is that I did what every other person does when they fall into money. You see, I had gotten a well paying job out of college, and I told myself that I had finally made it. I was able to buy whatever I wanted because money grew on trees for me now. But with that I started to create a standard of living that was within my means, but because I hadn’t saved for it first, I was actually living beyond my means. It took me a good number of years after graduating to realize that I needed to be smarter about how I used my money, and thankfully I’ve finally started to get things under control. Now, I can assure you, that the next time I need to purchase a sweet gaming PC, I’ll be sure to save up the appropriate funds first.
Looking at my journey to being able to actually start investing, I realize that I didn’t quite do it in the most efficient way, but I’ve learned some points along the way and wanted to get those thoughts down. If the first step to start investing is to get your own finances in line, you have to be able to know where your money is going each month. I sat down with Mrs Money Smith one day and forced both of us to think of everywhere our money went, (this was the start of creating our ‘budget’).
As it turns out, we had many different streams of money that were flowing out of our bank account each month, (this we knew), but they were all of various interest rates and minimum payments. For my debt that I brought to the equation, I had a credit card loan, a motorcycle loan, a car loan, and multiple student loans. Mrs Money Smith had the same, with that really smart motorcycle loan.
Our interest rates for all of our debts were in a range of between 2.49% for one of the auto loans, to 24.24% for one of the credit cards! Not all debts are created equal. Being the analytical person that I am, I created a spreadsheet in Google Drive to put down just how much we owed for each of our loans that included the interest rate and the minimum payment of each. From there I added a column of what the pay off order should be for each of those loans. The scientifically most appropriate way to pay off our loans was to pick the one that had the highest interest rate first and focus all of our surplus money into that loan.
There are two basic schools of thought about paying off debt. One is termed ‘the debt snowball’, this was made famous by Dave Ramsey who has turned this simple process into a huge sensation for people excited to follow someone’s lead in paying off their debts. At its core, the debt snowball says to look at all of your loans, and to pay off whatever the smallest amount owed loan is first, while paying minimum payments on all of your other loans. Once that smallest loan is paid off, you can take the amount that you were paying on that loan and move to the second smallest loan, repeating the steps with each loan along the way.
This approach is meant to introduce dopamine into your system when you finally pay off that first loan which will then get you excited about paying off the next loans and have you riding that wave all the way to zero debt. That approach isn’t good enough for me, because it just doesn’t make mathematical sense. If you take the emotional piece out of the equation, what you should focus on paying off first is the loan with the highest interest rate. The reason for this is because you will pay your total mountain of debt off faster if you focus on the piece that is adding the most to it each month.
Mrs Money Smith and I decided to attack our loans in this way and added another element to it. We decided that we would force ourselves to shovel all of our extra money to the loans at the end of the month and basically reset our checking accounts balance to a level that we felt comfortable. This amount was decided on by thinking about what lifestyle we want to lead and what miscellaneous expenses could come up for us within the month. This helped simplify the question of how much extra we could afford to pay each month, because we knew that whatever amount was in our account at the end of the month above our baseline was what could be sent to the highest interest loan.
By completing all of this work on the front end of our journey to financial freedom, we took all of the questioning each month of how much we thought we could actually afford. We didn’t need to look a month ahead and try to budget out a plan of attack or predict any expenses, we knew that we would be just fine because we had set our budget as a whole, in an easy singular step. Life was all sunshine and butterflies for us after this session because we both agreed on what our path forward was and we both understood why we were focused on this as a family.
Flash forward to present day and I know that having this planned out has helped us immensely. We’re actually still paying off debts, but now when we look at debts we look at them in a much more systematized approach. We are now at a point where we have paid off our credit cards and can start using them for a more important purpose. We don’t let amounts carry over from month to month, which allows us to take advantage of the perks of our cards, we use them to collect points for travel or to utilize the cash back that they provide. What was once our biggest chunk of debt has now become another tool to utilize in paying off our other debts.
I know what you’re thinking. You’re thinking that paying off every debt before you start investing seems like it would take forever. And you’re not wrong, that’s why I want to introduce another thought to you. You may only need to focus on paying off the debts that you can’t leverage to make even more money. To break it down, we have currently set our sights on paying down any debts that are more than 7%. To us, anything under that is essentially a small price to pay to be able to leverage our money better.
We are confident that our ability to invest would provide us with more than 7% ROI, (Return on Investment), so our plan currently states that once we’ve paid off anything over 7%, we will then start focusing our extra money toward other investment vehicles.
I will admit that we didn’t follow this approach exactly to the letter. Being so excited to invest our money and have it work for us, we have made the decision to put small amounts of money into other investment vehicles at the same time to explore their viability and see what ROI we can come to expect. Through doing this is how we decided on the 7% mark.
The way that we made this work for us was to sync up our debt payments with our pay schedules. We’re currently both paid semi-monthly which means we each get two paychecks a month, once on the 15th and once on the last day of the month. For the bills that we’re allowed to, we set up automatic payments that pay half of the cost on the 15th and half of the cost at the end of the month. Setting it up this way avoided any crazy swings in our bank accounts at the end of the month that we would have if we paid it all at once. This is also helpful because our bank sends the payments out the morning of our designated date. When we wake up and look at our account, we have the confidence that the money that’s sitting there right now is the amount that we can technically spend and not have to worry about.
There are some bills that just aren’t set up to be paid more than once a month, simply because the ability to program that into their system isn’t feasible, or because we actually receive a benefit of only paying it once a month. For instance, some of our student loans receive a discount on interest rates when they are set up on a draw from their website. The math works out in our favor to let them pull money from our account once a month instead of us pushing money to their account twice a month.
Sitting down and looking at our finances also unlocked another ability for us. I now have a spreadsheet that is a birds eye view of everything that we owe and own. It’s a series of tabs that I utilize to track our assets, liabilities, and calculate our total net worth. I’ll certainly post about that spreadsheet in future posts as I firmly believe that in order to take control of your finances, you need to actually see them all in one place! There are easy ways to do this, such as Mint.com or PersonalCapital.com, but for me each of those sites misses a few key features that my manual calculations can work around.
I plan to post our net worth in detail each month to be as transparent as possible and help understand the circumstances that we’re in to help drive further conversation around these topics as well. I’ll also explore the notion that not all debts are bad debts, my thoughts on various investment strategies, and how to leverage yourself correctly through diversification of assets.
Do you have any strategies about paying off your debts or points that I’ve missed? I’d love to hear them!
-Mr Money Smith