The fourth step in the how to become a millionaire series is to invest your money. By now, you are earning money, spending less than you earn, and saving the difference. But simply saving money will not make you a millionaire – you need to make your money work for you. That means you need to invest your money.
Invest Money
Once you establish your emergency fund, you should begin investing. There are literally thousands of ways to invest, so this is meant to cover only basic investing principles.
Pay yourself first. Add investing to your budget, make it automatic, and invest before you ever see the money. This way you don’t ever have to worry about “finding” the time and money to invest. Your system is already in place and you don’t need to worry about it except when you need to rebalance your allocations once or twice a year, or if you decide to invest more money.
Make it automatic. The same principle to automatic saving applies to automatic investing. Set it up so you don’t even think about it. That way, you know it gets done on time, every time. Many people choose to invest through payroll deductions in employer sponsored retirement plans such as a 401(k), the Thrift Savings Plan (TSP), pension plans, and other defined benefits plans. You can also set up automatic deposits to invest in IRAs, mutual funds, single stocks, and many other investments. Automatic investing is a painless way to ensure you invest.
Invest in tax advantaged retirement funds. The most common retirement funds most people are aware of are IRAs and 401(k) plans. But there are many other tax advantaged retirement accounts such as the TSP, 403(b), 457, defined benefit plans (such as a pension), multiple variations of IRAs including Roth and Traditional IRAs, and more. The good news is that you can have more than one retirement account.
These retirement plans have additional benefits over taxable investments – the investments can grow without taxes dragging down their value every year. For tax deferred plans such as a Traditional IRA or a 401(k), you invest money before taxes and pay taxes when you withdraw the money in retirement. Other tax advantaged accounts may be the opposite – you pay taxes now, only to enjoy tax free growth and withdrawals in retirement.
Find those accounts which you are eligible for, and take advantage of them – especially if you can receive an employer match on your contributions.
Leave your retirement funds in retirement accounts. The best thing you can do with the money in your retirement accounts is leave it in a retirement account. This means not cashing in a 401(k) when you change jobs, not taking loans from your 401(k), and not cashing in IRAs or other accounts before retirement age. The early withdrawal penalties for retirement accounts are steep. There are several options for your 401(k) when you change jobs and it pays to research which option is best for you.
Pay attention to asset allocation. Asset allocation is how you divide your money among your investments. There are many theories to the best asset allocation, but as everyone’s situation is different, there is no way to cover each asset allocation possibility in this article. Try to find a mix appropriate for your time horizon, risk tolerance, and your financial goals. The SEC has an asset allocation primer, or you can start by reading an investment book from your library. If in doubt, start with a life-cycle fund which uses professionally determined investment mixes that are tailored to different time horizons. These are a great place to start until you know more about your investment needs and risk tolerance.
Diversify your investments. If we were certain about a particular stock’s future performance, we could place all our money in it, wait until it rises to the right price, then cash it in and live like kings for the rest of our lives. Unfortunately we don’t know what will happen, so it’s best not to put all our eggs in one basket.
A better solution is to diversify our holdings by purchasing investments in different asset classes and sectors – stocks, bonds, index funds, mutual funds, real estate, precious metals, large size funds, mid size funds, small size funds, growth funds, value funds, international funds, etc. It may seem daunting at first, and for many people it can be. Again, a good place to start is with a life-cycle fund which is automatically diversified for your time horizon. That doesn’t mean you have to leave it there, you can always learn more about other types of investments as you go. They key is to start investing as soon as you can.
Start investing as soon as you can and don’t stop. Compund interest is one of the most powerful forces in the universe. The longer you let your money grow, the greater the impact compound interest will have. This is illustrated nicely in The First Million Is The Hardest. By looking at the chart on this site, you can see that by starting at age 25 and investing $15k per year at 10%, it will take 20 years to reach the $1 million mark. But by continually investing afterward, it only takes 6 more years to reach $2 million, 4 more years to reach $3 million, 3 more years to reach $4 million, 2 more years each to reach $5-7 million, and one more year to reach $8 million. Compound interest truly is amazing! But the key ingredient to compound interest is time. So get started!
{ 5 comments… read them below or add one }
I like this part. Maybe because I focus so much on this step I am decades from becoming a millionaire for the first time
As my algebra teacher told me once ” I’m now working on my second million. I failed at making the first one, so I decided to start working on the second one “
The power of compounding interest is absolutely amazing!
I remember running “scenarios” when I was in college about hypothetical returns on only marginal investments. It doesn’t take too much time to accumulate $1,000,000!
Great tips! When I started investing, I only put in $25/month. As learned more about compound interest, I increased my deposits when I got raises.
Compounding interest is fascinating. But it also applies to stocks, not just for deposits. In fact, if you have picked some great dividend paying stocks that have increased their dividend payments over time you would have achieved double the compounding effect.
If you had invested money into a hypothetical Dow Jones 30 ETF on 12/31/1919 you’d have received $5.80 in dividends in 1920. The index closed on 12/31/1919 at 107.23 accordin to DJ -
http://www.djindexes.com/mdsidx/index.cfm?event=indexHistory.
Fast forward 80 years and assuming that your ancestors and their heirs up untill you spent all the dividends every year. And your investment is worth a little over $11000, but brings in over $250/year.
http://www.valueline.com/pdf/valueline_2006.pdf
Great posts.
I recently started My Stock Market Journey and I am learnng how important it is took include dividend paying stocks as they really hope to boost your earnings. And I honestly did not think of the compounding effect until I read this post.
Thanks for sharing.