To decide on when to invest, one must understand what “investing” actually is. There are many forms of investing, and not all are particular to financial investing.
It has often been written that investing in others, yourself, and your family is productive. Arguing the counterpoint would be a challenge to win. Expending time, energy, and/or money into something for expected tangible or intangible future benefit is the definition of “investing”. You can invest in yourself for future benefit. This often is often done through education and health orientated activities. For relational investing, you might consider taking a date night once a month. The future benefits of investing in your spouse and marriage can be immense. The cost of the time (the meal, activity, and baby-sitting) is tangible, but the relational health of your marriage is often an intangible result. So from this perspective, one should ALWAYS be investing. In your kids. In your spouse. In yourself. In your friends. In your community.
When to “Invest” Financially?
Investing financially is expending money into a property, idea, business, or security with the expectation that one will have more money over time and reap the benefit. The question of when to invest is probably more important than the question of “how” to invest. One should consider investing financially when a few personal boxes are “checked”:
- Day-to-day living expenses are covered by regular income or cash flow
- A savings/emergency account is funded to provide for the unpredictable expenses
- Personal credit is eliminated or maintained to a trivial portion of the day-to-day expenses
- One accepts the risks associated with “investing” and that one might lose some or all of original investment capital
Once these boxes are checked, then the “when” can become clear. History has shown that the sooner the better. Often employers will offer an incentive to investing in the form of their qualified employer sponsored retirement plan (typically a 401(k)). A 401(k) retirement plan affords employees with the option to defer income and federal taxation for years down the road (59 ½ is the age when the standard penalty for early withdrawal is removed). If your employer offers a matching component, then one is incentivized to contribute. As an example, a matching component is when the employer may say if you defer 3% of your compensation per pay period, then we will match you dollar for dollar on that first 3%. 401(k) retirement plans vary from employer to employer, so always read the fine print to fully understand if they offer a matching component and how it works.
The Risk-Reward Tradeoff
The phrase, “the higher the risk, the higher reward” is generally a true statement. In today’s world, this is truer than ever. If an individual “invests” $25,000 in a bank account, they are taking little or no risk (the funds are FDIC insured) of losing principal, but the reward is very low (might be able to earn 0.00% to 2.10%). The same person could “invest” $25,000 at the roulette table at the casino, choosing “Black”. The person would have a 47.36% chance (18 of 38 spots) of having $50,000, and 52.63% (green & red are 20 of 38 spots) chance of having $0. The risk, losing $25,000, is high. The reward, doubling your money to $50,000, is also high. The capital markets are full of different investments, securities, properties, companies, and much more. Each investment must be evaluated for their own risk-reward profile.
What is the Intention of Investing?
If one is deferring income into an employer sponsored retirement plan, the intention of the funds to provide and plan for retirement. But what if an intention or goal is not as long-dated as retirement? People will save and invest funds for all different reasons, ranging from a primary home, to a vacation home, to vacations, to education for children, and list goes on. This is referred to time horizon—when the funds will, or likely, to be spent. If the time horizon is short, then normally lower risk, lower reward investments are more appropriate. A shorter time horizon will usually lead to a more conservative investment objective. If the time horizon is longer, then one has more compounding periods available and the ability to accept the risk-reward profile of a longer dated investment, which leads to a more aggressive investment objective.
It is extremely important to align your intentions and goals with your time horizon and investment objective. Misalignment will often lead to poor decisions and management of investments. Talking with your family and trusted friends and professionals who have your best interest at heart will help people be properly aligned.
Author: Adam Chaney, is a Certified Financial Planner,CFP®, Chartered Retirement Planning CounselorSM (CRPC®), Accredited Portfolio Management AdvisorSM (APMA®). Adam lives in Warrenville, IL with his wife and four young boys. His office with Optimal Wealth & Investments and LPL Financial is in Naperville, IL. Adam can be contacted at adam.chaney@lpl.com or 630-544-5350. His comprehensive personal wealth management services help people build, preserve, and distribute their wealth through ethical and effective means.
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