Many articles about investing for beginners will start by encouraging you to identify risk tolerance and then invest small amounts in High-Yield Savings, CDs, a 401(k), Mutual Funds, ETFs, and/or Individual Stocks. Some even encourage the use of investing apps to invest a few cents, or a few dollars, of each transaction to make the process more automatic.
In this piece, we take a different approach to investing for beginners by encouraging a strong foundation of savings before you start investing. Saving is often confused with investing, but they are fundamentally different. Savings should be money that remains safe and available to you. Over time, some savings may be invested, but investing always involves taking on a risk of loss through an attempt to earn a higher rate of return.
People recognize they can lose money when they invest, but risk seems to be increasingly more acceptable to the point where the value of building a safe and secure foundation is downplayed. Despite this trend, guaranteed savings is still key to a vibrant financial life.
Investing may seem more exciting than saving and perhaps this is why it attracts more attention. In the last 100 years especially, investment products have been packaged and marketed to middle-class customers in an ever-growing array of options which makes investing more accessible than it used to be.
But consider the case of John and Sue who maximize contributions to their 401(k)s and are not able to accumulate extra money to start a business when they run across a wonderful opportunity in their 40s. The money in their 401(k)s is locked up under a 10% penalty + taxes before age 59 ½. This creates a huge lost opportunity for John and Sue.
Or what about the case of Bill and Christy who are real estate investors? They find properties to buy low and sell high, but real estate investing often requires access to cash and good credit. If Bill and Christy invest too much of their cash in the stock market, while they’re searching for good real estate, and the market is down when the good real estate deals come along, they may have to take a loss on their stock investments or wait for stocks to come back up while they lose potential in the real estate market where their true expertise lies.
Another common situation is the average American who invests in a 401(k) and carries credit card debt at the same time; they’re paying more interest on the credit card than they can make through the investment in the 401(k).
Whatever the situation, these are examples of investing too much before establishing a good foundation through savings.
Even though investment products and apps are available to help people start investing with just a few dollars at a time, we believe the risk assumed through such an approach cannot justify skipping a strong savings program.
Examples of investing strategies that should not be confused with savings include:
Many proponents of investing early in life, despite a lack of foundational savings, are quick to point out that inflation will erode the value of money which is saved earning a low return. Inflation is indeed a hidden tax. Thomas Sowell says: “It is a way to take people’s wealth from them without having to openly raise taxes. Inflation is the most universal tax of all.”
But there are various financial tools that lend themselves to establishing a strong savings program and work against some of the effects of inflation including:
Out of these 3 options, whole life insurance cash values provide great accessibility and long-term guarantees as well as life insurance protection. High-yield savings accounts do not always pay high rates of interest, and CDs by their very nature come with some access limitations.
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Just because you focus on savings first doesn’t mean you cannot invest too, but it is wise to consider your balance between saving and investing and to be clear when you are considering one versus another in your plans for the future.
The proportion of saving and investing can be very different for each person based on their situation and aspirations. Finding the right balance is still key to achieving your goals efficiently.
If you do not have a strong savings program, consider starting one right away by using the 10-20-70 rule as a guide. The 10-20-70 rule comes from the book The Richest Man in Babylon by George Clason. Written in 1933 as a collection of stories based in ancient Babylon, this book shares the principle of saving at least 10% of everything you make, paying no more than 20% of your income to creditors and no more than 70% to supporting your lifestyle. If you are debt-free, this ratio naturally becomes at least 30% of savings without working any harder.
10% is often a good starting point for the premium on a whole life insurance policy designed for high cash value because this makes a great foundation for long-term savings. I typically subtract taxes before applying the 10-20-70 rule, so I’m just working with after-tax income. You can run your own numbers through the 10-20-70 model on our website.
Once you have a strong savings program in place, the world is your oyster and you can more freely explore investment options for higher potential returns, and sometimes even tax benefits, that can be combined in a way to maximize the value of your money at work for you.
You can also afford to have more patience (and less stress) in riding the market rollercoaster when necessary, and more clarity about what you really want from an investment rather than being dependent on your investments out of bare necessity.
At this point, some of the mainstream advice on investing for beginners makes good sense including:
Warren Buffet is quoted as saying that diversification is protection against ignorance. It makes little sense to those who know what they’re doing. This quote conveys truth on a couple of levels.
Many people who are beginning to invest do not have the level of knowledge, or experience, that allows them to choose investments with the level of confidence that Warren Buffet has earned the right to express in this manner. But even Warren Buffet occasionally makes an investment choice that doesn’t work out so well.
Keep in mind, there will always be some level of ignorance as you’re researching most investments. Sometimes investment experts are most blinded to this risk because they become too confident in their own experience.
Investment options for beginners are usually assumed to have a low barrier of entry from a dollar amount perspective. This is why various retail investment apps, robo-advisors, and retirement plans are commonly recommended starting points.
But once you’ve established a strong foundation through savings, the best investments are not so limited based on the amount of money because you’ll have plenty to tackle some of the larger investment options too. For a more detailed list of investment options, check out our article on Types of Investments.
Good investment options may include some of the same vehicles that are commonly recommended to beginner investors but based on my experience, and going back to Warren Buffet’s quote, the best investments are usually in an area that you personally have an interest in or strong knowledge about.
For example, I have a great interest in stock options. I’ve studied how they work, enjoy investing some money in this way, and manage the portfolio from day to day. But stock options can be complex instruments and some situations can leave you exposed to huge risk. This type of investing is not for everyone.
Other people I know enjoy construction work and have studied real estate investing. They like to use their savings to invest in local real estate projects which they research and can personally be involved in. They do well in real estate.
But the best way to lose money in many investing scenarios, including real estate, is not to have a good knowledge about what you’re investing in. An advisor can often help with specific knowledge and strategy, or help guide you in the process, but ultimately the decision is yours to choose a strategy that best aligns with your goals and opportunities.
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Many people invest money toward retirement as a future goal and as they approach retirement, they wish to have less risk from market volatility than they may have assumed earlier in life.
Theoretically, market volatility is decreased in an investment portfolio by allocating a larger percentage to bonds rather than stocks. The reasoning goes roughly that bonds and stocks don’t usually go down together, and bonds provide some regular income that can help sustain withdrawals from an investment account.
While bonds still provide regular income, they may not provide as much protection against market volatility as they did 30 years ago. In recent years, bonds and stocks often crash at the same time. It seems there is no great solution for an investor following the typical routine who suddenly finds themselves in the dilemma of wanting to retire with the market recently crashed – these people often have to work longer or accept a lower standard of living.
Knowing this situation is a possibility, provides the potential for you to plan in advance and avoid it. Building a foundation of guarantees through whole life insurance before you get to retirement can provide a nice buffer against market volatility as you approach retirement. Guarantees can also be extended to an income stream in retirement through annuities that do not expose a policyholder to unnecessary risk through market-related factors.
Annuities will often restrict access to money, so they are not always good tools for saving or investing during most of your lifetime, but they do have a place in retirement and other situations where a steady income is desirable.
Whichever way you approach the idea of building your financial future, we believe there are more benefits through a combined system of saving and investing rather than relying upon investment solutions alone. Starting with clarity on the differences between saving and investing can help you build a strong combination of both.
At McFie Insurance, we specialize in helping people like you maximize the savings aspect of their finances through high cash-value whole life insurance. We design and sell these policies to help people get the protection they need and guaranteed access to savings throughout their lifetime.
Call us at 702-660-7000 or schedule an appointment here to see what the numbers look like in your situation. We look forward to serving you.
by John T. McFie
I am a licensed life insurance agent, co-host of the Wealth Talks podcast and co-author of Retirement Curveball.
At age 14 I started developing spreadsheet models and software systems to help my Dad share financial concepts with clients.
Skipped college at 17 recognizing the overinflated value and prices of most college degrees and built more financial software instead (see MoneyTools.net). Still a strong advocate of higher education without going to college. I enjoy making financial strategies clear and working through the numbers to prove results you can count upon.
Investing information provided on this page is for educational purposes only. McFie Insurance does not offer advisory or brokerage services, and does not recommend or advise investors to buy or sell particular securities.