“Alright, you have made it to my first post in this blog, thank you very much for your interest. Let’s get started….” – Raphael –
So, my first posts will be about some principles of investing money and some basic rules, that I have figured out for myself over the past 5 years. These rules / statements will be valid, whether you want to invest in the stock market or other assets. But let’s keep it simple in the first step.
The answer to this question is quite simple – there is no answer, at least no specific one. The question should rather be “How much money are you able to invest?” and “How much money are you willing to invest?”. This is important, because it will change your perspective and take two crucial topics into account, before you start investing:
- Your financial situation considering your income, expenses, assets & liabilities
- Your risk tolerance
Determine your financial situation first
Before you start investing your money, you should exactly be aware of your financial situation. It can be easily determined by tracking your finances constantly in some sort of spread sheet, with which you record every euro / dollar that you earn versus what you spend monthly. By doing that for a period of 12 months you will have a very accurate overview of your financial situation, also considering expenses, that you only pay once a year, for example for your car insurance or your subscriptions to a Netflix or Amazon Prime account or whatever.
This will help you to get a better understanding of your financial situation, especially in terms of your expenses. Although this is a quite simple approach, a lot of people unfortunately do not keep track about their financial situation. Let’s take a look at an example to track your finances on a monthly basis:
According to that, your total monthly income equals €2,500 and your total monthly expenses add up to €1,930, leading to €570 of free cash left over. This is your remaining monthly buying power, that you can either use to spend, save, or invest.
If you own a house (asset), for which you have to pay off the mortgage (liability), you can do the same calculation as described above, but instead of considering a monthly rent, you just consider the monthly payment for the mortgage and of course additional annual expenses, e.g. for insurances that you need to protect your asset. Moreover, additional supplementary bonus payments can be considered too.
What about debts?
Do you have any debts, especially bad consumer debts, like credit card debts or an overdrawn bank account? If you can answer this question with “YES”, I highly recommend you to pay of these debts first before you start investing. These debts are limiting your ability to invest and to profit from your investments in several ways. First, they limit your ability to invest your money monthly, as you need to pay of your debts monthly too. Second and more important, the interests that you need to pay on these debts are insanely high (~20%), while the average annual stock market return is 7% per year.
Identify your risk tolerance
Alright, your financial situation has been determined, so in principle the question of “How much money are you able to invest?” was answered. Your remaining monthly buying power is €570. The next question is “How much money are you willing to invest?”.
This is a more difficult one, as it highly depends on your personal situation. At first you should always consider to have some emergency funds of at least 3-6x your monthly net income (€7,500 – €15,000, considering the example described above) saved in your bank account, to be able to react on unexpected expenses, e.g. for a car repair. If you own a house, that you need to pay off, or have a family to raise and feed, your emergency fund probably should be even higher. This should be your main priority before you start investing. Otherwise you are potentially in the need to sell your assets with a loss (e.g. due to short-term downward fluctuations of the assets price), to cover other expenses. By that you will not only spend your money on the car repair, but also generate an additional non-recoverable loss on your investments.
Moreover, if you are planning to buy a new car within the next 2 years, or to buy a house in the mid-term, you probably should save the money for that, rather than investing it today due to the same reason as mentioned above. But let’s assume, that you already saved enough money as an emergency fund and there are no plans for bigger investments in the mid-term.
What about your emotions?
There will be a more detailed post about this topic at a later stage, because controlling your emotions is a key component to success. But think about following situation. You invested your remaining €570 on a monthly basis over a period of 1 year in the stock market, and after a decent year you are 15% in profits, adding up to a stock portfolio with a total value of €7,866 and a profit of €1,026, not bad at all. But suddenly, due to a financial crisis the stock market falls 40% in a few weeks and you end up with a portfolio value of €4,720 and a loss of 31% or €2,120.
Take your time, to think about how you would feel in such a situation and how you would react. 1/3 of your initial investment is gone. Would you panic and sell all your assets with a loss? Markets are very volatile and act in cycles, sometimes it can take years for the markets to recover after a drop. But long-term, they always have proven to recover and to set new highs. Patience is the key in such a situation, or as Warren Buffet said:
“The stock market is a device for transferring money from the impatient to the patient”
Of course, there are many more points that need to be considered in such a situation, e.g. how to hedge your portfolio to avoid bigger losses, but this will also be covered at a later stage. Considering a potential downside will help you to choose the right amount of money to start investing, and second will prepare yourself and strengthen your mindset for such a situation.
If you are new to investing, my recommendation would be to start investing small amounts first, to get used to the volatility and moreover, to only invest an amount of money that you can afford to lose, and that you probably will not need within the next decade. Take your time, to get used to investing your money in the stock market, and educate yourself in parallel, before you start investing a higher proportion of your monthly income or net worth.
And finally, the younger you are, the more riskier you can act. Risky decisions need to be taken as long as you are young and as long as you do not have to many obligations, e.g. regarding your job or family. You are at the very beginning of your life, you are more flexible in case you make some wrong decision, and you can afford it to lose money due to these wrong decisions, because you will be able recover your losses over time. Moreover, you will highly benefit from the compound interest effect, if you start investing at an early age. Don’t get discouraged in case you lose money, but rather take it as an opportunity to learn from your mistakes and educate yourself further.
In terms of our example, a good starting point from my point of view would be, to start with a monthly investment of €200.
7 bullet points of what you need to consider, before you start investing your money:
- Determine your financial situation and your remaining monthly buying power
- Build up an emergency fund, to stay afloat at any time
- Pay off any bad consumer debt
- Start investing with small amounts, to get used to the volatility of financial markets
- Never invest more money, than you can afford to lose
- Never invest money, that you probably need within the next 10 years
- Risky decisions need to be taken as long as you are young
Follow my next blog post in the category “Investing 101”, to learn what were my biggest mistakes, when I invested my first €500 in the stock market.