Are you a young professional? Do you have some savings? If so, then you’ll have thought about how to make those savings grow. Regardless of how you decide to invest your savings, here are a few things you should keep in mind:
1. Pay Down Debt Before Investing
I was once asked by someone if she should pay down credit card debt with her savings, or invest the money instead. If you have credit card debt, I absolutely categorically recommend that you pay that down first. In fact, unless it’s a mortgage, pay down all your debts before you start to invest.
Interest saved is interest earned, and most investments won’t earn you the kinds of returns you can earn by paying down debt!
2. Look Down, Not Up
Many young professionals have the following attitude. “I’m young, so I can take more risks. Give me the riskiest investments." In theory, this makes sense. But in practice this is often a bad idea. Stocks, for instance, could lose you as much as half of your savings temporarily. They’ll always gain it back, but in the midst of such collapse, many people panic. When they panic and sell, they sell at exactly the wrong time.
We’re all emotional beings. There’s only so much we can handle emotionally. Take time to properly understand your limits.
3. Understand That You Trade Risks for Returns
No one can predict stock markets or bond markets, especially in the short run. You can get a low guaranteed rate of return, or a high potential return with unpredictable short term outcomes.
There is no such thing as a high guaranteed rate of return. Run from anyone who offers you such ideas.
4. Performance is Relative, Not Absolute
Say you hire a financial advisor, or use a service like MoneyGeek. Your investments do poorly. Did you trust the wrong people? Not necessarily.
Let’s say the stock market as a whole went down 10% in a given year. If your stocks only went down 5%, your advisor/service did well. On the flip side, let’s say the stock market went up 20% in a year. If your stocks only went up 10%, your advisor/service did very poorly.
5. Use Correct Benchmarks
Many untrustworthy financial advisors will sell you a mutual fund, and compare their performances against popular indices like the Dow Jones, S&P 500 and TSX Composite. The problem is, most of those indices don’t take dividends into account. So if the TSX went up by 7%, you’ll have to include the dividends - perhaps 3% more, to the total tally. Thankfully, there are indices that include dividends for you. These are called total return indices. For example, use the TSX total return index, or the S&P 500 total return index to really evaluate your advisor’s performance.
Run from any advisor who boasts that their mutual funds beat the non-total return index.
6. Really Understand Your Goals
Many boomers are thinking about retiring in the next few years. Here’s a common question: “I have $400,000. Is that enough to retire on?” The answer is usually NO.
Here’s the simple math. People today live longer, so they may live 20 years after they retire. If a boomer wants to withdraw $40,000 (pre-tax) a year from their savings, that’s $800,000 that they have to finance, adjusted for inflation. Can you generate that kind of investment returns? Not likely.
7. Seriously, Take the Time to Learn
Everyone knows how to cook. It’s not fun for all of us (including myself), but we learn anyway. Why? Because if we didn’t, we’d have to eat out all the time, and that costs a lot of money.
I feel the same way about personal finance. If you don’t know how to manage your own money, you will bleed money, often without knowing. Sometimes, the numbers can be staggering. Thankfully, it doesn’t take that much effort to learn the basics of personal finance.
If you can cook, you can learn personal finance. Now, you have no excuse!
*** Dr. Jin Won Choi is the founding geek over at MoneyGeek.ca, this is his first contribution to the #owngrowprotect blog ***
This is the second post in our series: Short Week of Lists - Own Grow Protect