There is only one way to build wealth: Investing Simplified

I remember the first time that I began investing. It was 2007 and my supervisor suggested that I contribute to my employer’s 401k plan. I had no clue of how the stock market worked or how to invest my funds. I had always heard that magic phrase “diversify your investments” so I put my money evenly across ten different types of funds and called it a day. Years later, after completing my CFP capstone courses I realized how ignorant my investing logic was. With information so vast and free; I could have “googled” my way into the proper way to invest for retirement. However, like most people, I just listened to what others had done. Those others were not wealthy, nor financially brilliant. It was not the best of decisions. Luckily, we all can change investments at any time.

An investment is a monetary asset purchased with the idea that the asset will provide income in the future, or appreciate and be sold at a higher price. (Investopedia, 2016)

Investments are generally stocks, bonds, cash equivalents and real estate. Other investments vehicles can combine these products into other packages such as mutual funds (stocks/bonds/cash equivalents), CD’s (bonds), and high yield savings accounts (cash equivalents). All investments share one common trait, the growth of the principle balance by way of interest and/or appreciation.

What is the S&P 500?

Simply put, the Standard and Poors 500 is an index of the 500 companies with the largest capitalization.

What is a Mutual Fund? 

Mutual funds are investment strategies that allow you to pool your money together with other investors to purchase a collection of stocks, bonds, or other securities that might be difficult to recreate on your own. (Fidelity, 2015). A Mutual Fund is generally an investment vehicle that contains 90-5000 stocks, bonds, or other investments. My favorite Mutual fund is VTSMX, an index fund (mimics the S&P 500) that spreads my investment across 3,700 stocks. This creates a broad diversity rather than investing in a single stock which is something you should never do. If I owned a single company stock, I would sell it today!

Who should invest? Why should you invest?

Everyone needs to invest who has eliminated basic consumer debt (all debt except your home). There is no excuse I can think of for a person not investing. If you stuck $100.00 in a cookie jar on January 2016, what would that value be today? Hopefully $100 right? But what would the value of that $100 bill be worth in ten years? How many gallons of gas is it going to buy? You would have to agree that the value of that money would suffer from inflation (prices of basic commodities increasing each year on average of 1-3%). This is also known as the time value of money. If you don’t invest you are allowing your money to lose value when it could be working to duplicate itself. If you are stashing coins in jars, you would make out much better counting it up and investing in a no-load index fund and that would prevent your nickles from becoming pennies in the future.

If you are broke, you should not be investing. It makes no sense to invest and make your current financial situation even worst. Those extra funds could help you get out of your hole and you can invest when you are more stable.

Compound interest

Albert Einstein was quoted as saying that “Compound interest is the eighth wonder of the world. He who understands it earns it… he who doesn’t… pays it.” Compound interest is the magic of a principle amount, let’s say $10,000 turning into 11,000 after a year of earning 10% interest and the next year becoming 12,000 and so forth. If you started a Mutual Fund today and invested $5,000  with the intent to deposit $500 monthly into that fund, it would grow to $1,230,000 in 30 years! $500 to retire a millionaire, seems pretty simple. But what if we wanted to accumulate wealth and enjoy it in the near future? That same $5,000 deposit and $500 monthly would be $46,000 in 5 years.

What would you do if you had $10,000 lump sum payment right now? My guesses would be:

  1. Down payment on a home.
  2. College funding for kids.
  3. Pay down debt
  4. Pay for a vacation
  5. Down payment on car

Would you think about a $10,000 lump sum differently if I told you that if you placed in a mutual fund and set up a $100 direct deposit monthly, that in 30 years it would be $425,000.00?

What should you invest in?

I believe there is a formula that everyone should use to ensure they are wealthy in the future instead of eating dog food or relying on family or the government in retirement. Having money is a process of planning to have money. If you aren’t planning on having money… then you probably will not. As far as planning for retirement you should focus on investing 10% of your income through the steps below (in order)

*for example if your company offers a match of 5%, you invest 5% and then invest in through the next steps until you reach 10%.

Step #1: Invest with your employer, only if they offer a match. If your employer offers a match, take the free money! Many companies offer 2-6% matches on 401k plans, I would not invest a single dime above that match. Ensure that you don’t select “target dated” plans, invest in the S&P 500 index (this will save you tons in expense ratios vs. actively managed funds)

Step #2: Invest in a ROTH IRA. This is the 2nd best option after a match, this is not a fund but a designation of an account. Roth IRA’s (Not to be confused with IRA’s) is an after-tax contribution account that grows tax-free. All interest earned in this account is yours to keep. The current funding max is $5,500 annually ($450 per month) per person who earns an income (2016). If you earned $50K per year the Roth alone would satisfy your retirement needs. If you were 30 and invested 400 per month in a Roth, you would have about 1.5 million (with no taxes due) at age 65.

Step #3: Invest in an IRA. IRA’s are funded with pre-tax dollars and are taxed in the future at retirement. There are tax advantages today for IRA’s, but you will be giving up a huge slice of pie in the future; as you are taxed on growth and contributions to the account at retirement.

Other investments include real estate which provides the best return on investment. I love the buy and hold strategy but advise against taking out mortgage loans to acquire properties. It makes no sense to carry several mortgages only to appear profitable at an arm’s length. One major expense will wipe away your $200 profits, and it will take years to make those funds back. That doesn’t include vacancy, headaches, and property damage.

Certificates of Deposits (CD’s) and Bonds are poor investments with too little interest gains to make the investments worth the time. I only invest in Mutual Funds and real estate with an emergency fund that can pay all expenses for 3 months.

Morningstar provides tons of information on Mutual funds and whether you are investing at work, in a Roth, or a 529 plan your funds are most likely in a Mutual Fund. One suggestion is to google, research, read, and call a broker to identify what best works for your needs. Beware actively managed funds, you do not need a master broker to “beat the market”, the market returns are great in the long-run. Never monitor how your investments are doing monthly or yearly, you are investing for a 15-30 year period and what happens today doesn’t matter.

You can set up your accounts with Vanguard, Fidelity, or JP Morgan. Doesn’t really matter which broker you use, really what matters is the product. Which should be a no-load index fund with a 10+ year track record showing returns greater than 7%.

*Disclaimer: This blog is not meant to give financial planning advice, it is simply giving an opinion based on logical data that can be retrieved from sources quoted in this article. There is no affiliation between this blog and any other site. Financial advice should be sought from a certified financial planner and financial decisions should be made per the readers own research and analysis. Investing involves risk and it is advised that no one invests without understanding fully the products that they are purchasing.



  • Our Frugal Escapades
    / Reply

    This was a very interesting read! We invest in mostly index funds and believe Vanguard has some of the best around. Just curious…what do you think of the fund VDIGX? We recently moved our funds over to that within our private brokerage account. We also made it a drip account as well. Any thoughts? We will be checking out the one you like VTSMX. Love that Einstein quote! It’s too bad so many people miss out on the benefits of investing. Compound interest truly is a wonderful thing!

      / Reply

      That’s for the reply, I actually read John Bogle’s book “Common Sense on Mutual Funds” it was 600 page read but quite worth. In summary the Vanguard founder only recommends low cost no load mutual funds and warns to ignore market ups and downs. VDIGX is a great fund and Morningstar has it ranked well. I actually really like that fund and may use it as an earmarked car replacement fund! I currently don’t own any dividend growth funds and it has a good 8%+ annualized rate of return vs the 7% in VTSMX over the last 10 years. They both are large blend growth funds with no load. The biggest difference would be expense ratios.17 vs .33 and VTSMX is 99% us stock allocated

  • Josh
    / Reply

    Great read Ron, breaks it down really well. “No excuse not to invest” is spot on. I’m curious though, are you implying that people should invest rather than pay down debt? I understand you might gain an average of 6-7% in a mutual fund, and a mortgage might be costing you 5%, nets you 1-2% after cancelling out. Could it be more valuable to clear out the debt first?

      / Reply

      I believe that in order to build wealth you must eliminate all debt except the mortgage before you being investing. The mortgage should get attacked after investing 10% of your income in the order listed above.

      All extra funds beyond the 10% should go to home payoff. I plan to write a blog post about my 7 year home payoff in a few weeks. As far as the 1-2% net, I would say you shouldn’t look at your home as a liability, because it is also an asset. I am not suggesting investing to those who have no savings and debt.

      Thanks for the reply, I added a line referencing debt and investing.

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