start to invest: cover the basics

Making the step from a savings account to an investment account is not so straight forward. In Belgium, the last years (2012-2014) there were regularly new record highs in money parked into a savings account. By sharing the steps I made, I hope to educate people on saving and investing.

Making the step from saving to investing is a step that we all take in a different way. Some jump straight in, others need to get used to investing one small step at the time. So, rather than outlining a path, I plan to outline the different components. Lets start with the basics

Understand your means: have a budget

This is basic. if you want to save and invest, then you need to understand your means and life well below your means. You need to spend less than you earn. the difference can be used to save and invest.

Does it mean that you need a full detailed budget file where you log all and everything you do? Maybe, but I am sure you can do it with less.  Does it mean you can just go along and hope for the best. Probably not.

I have been budgeting for 15 years now, it is now a habit, it is part of my day-2-day routine. It evolved in something that you read so often: pay yourself first.

what does this mean? Once you have established a budget you can live on, you know the amount of money you need  for your spending. At the time of the payment of your salary, put the surplus into your savings account, so you no longer see it. You have now paid yourself!

Set up an emergency fund and medium term savings

Life is full of good and bad surprises. Enjoy the good ones, be prepared for the bad ones. One of the preparations is to make sure you have direct access to money in case of an unforeseen event. I would not like to go through an emergency and at the same time have to worry about access to cash. The cash should be there. Directly. Always.

This is where the emergency fund helps. It is an amount of cash that you have set aside in an easy to access, save solution. Most likely it will be a savings account. Even if the savings account can’t keep up with inflation, I think it is still worth doing so. Other alternatives, at least in Belgium are TAK21 accounts. Once they are 8 years old, they actually behave like a savings account, but they have usually more interest than a savings account.

How big should this emergency fund be? There are a lot of rules of thumb: some say 3-6 months of salary, Other prefer the 6-9 month range. Others use 6 months of expenses. It should be as big or as small as you think.

Some factors are:

• do you need to take care of others (children, your parents,…)
• how much of your expenses can you drop (cable, Internet, car, entertainment,…)
• how flexible in life are you (if you rent, can you move in with your parents or a friend)

Another item that I factor into the same segment is the need for cash in the medium term. This can be cash for a house renovation we might plan to do,  a big holiday we want to make. These are items that you generally plan ahead and that you can save for. That is the reason that a part of our savings is set aside and does not go into the investment fund. It is actually not even considered saving: it is considered an expense when I calculate my savings rate. Why… it is money I plan to spend in the future.

With my wife, we have settled on 1 year of expenses. The fund includes the emergency fund as well as the planned expenses fund for the next 3 years or so. This means that in case of an emergency we are willing to delay house improvements, holidays and other non essential expenses.

Tax Pension accounts

Most people have access to a form of saving with a tax advantage. In Belgium, we have pension saving. We can invest 940€ per year in a special account and we get 30pct back via the personal taxes. Not too bad. Around pension age, some tax is put on the savings and the rest we can keep (except for a special tax that the government will take the next year…pfff)

In general, it is highly recommended to start as early as possible. IT creates a good habit to invest for your retirement, IT is a sort of euro cost averaging (good for most people), it can be a first step to investing.

There are 2 main products out there: insurance savings with a capital guarantee and investing in a fund. Both have their merits. Being rather young, I prefer to have the investment fund. Some research has shown an annual return of 6pct. Not too bad. And this excludes the 30pct tax benefit. Via a search on the web, you easily find websites that explain what situation calls for what product.

Long term saving / mortgage saving

While the above sections are country neutral, the following has some more focus on Belgium. You will have to figure out how it works in your country.

When you own a house with a mortgage and you meet certain conditions, then the Belgian tax system will be nice to you an grant you a tax benefit. Just use it.

If you fall outside of the right conditions, then there still is a way to get a tax benefit (at least, there is now in 2015): the long term saving. This is a similar system that gives you a tax benefit of 30pct on the amount saved. Compared to other countries like the USA or Canada, there is a downside: it is money that you park in a special insurance account. At least, as far as I can see today. If you see other alternatives for a Belgian tax payer, let me know.

Get ready for the investing

When you have all the above covered, or you have at least a plan in place, then you are ready to start investing. There are the typical warnings:

• Investing should only be done with money that you do not really need.
• Investing is for the long term, look at a time frame of 5-10 years
• You can make paper losses: the markets can drop a lot in a day, week or month. Are you ready for this.

There are many ways you can invest: You can buy individual stocks, you can buy an index, you can buy active managed funds. There are even more products like derivatives, but lets be serious, these should be used when you have some experience with the basic products.

A good way to start is to take a small amount of the money you plan to invest and deploy it in the strategy that you think is best for you. Nothing beats being really in the market. You can think about it, talk about it, but by doing it, you now how it feels.

There is the risk to loose your money, even all your money. Therefore, you need to take care to follow some basic rules

• Diversify: do not put all of your money in one and just one individual stock. This one stock can go bankrupt. Maybe unlikely in your opinion, but ask some people that have been there. Just do not do it.
• Stay away at first from derivatives and leveraged products. With these products it can go very fast and you are more likely to loos all. With margin accounts and leveraged accounts, the loss can be more than what you started with.
• Do not start with exotic stocks that you heard off that they will make very soon a big profit. If it sounds too good, then it probably is…

Once you through all of this advice, you should get started. It will take some time to find the style you like, you might need to figure out what suits you best. On paper you might prefer one thing, in real life, it might the other thing you like.

Type of investment styles

Below is a first and short introduction to a selected set of investment styles. I hope they can inspire you to do your own research and pick a style you want to put in practice.

• Dividend growth investor

You compose yourself a diversified (region, industry) set of stocks that have a strong history in paying each year a dividend. This dividend even grows each year. The aim is to have a yearly dividend stream that covers your yearly expenses.

Before buying you should have a set of rules that you follow: what yield (dividend/price) do you want, what price/value ratio do you find acceptable.

Your countries tax rules might impact your dividend

• Value investor

In this case, you follow the same principles as Warren Buffet: in short: you buy companies that are priced way below their intrinsic value. This requires you to research and understand the company you want to buy. It also requires patience: you have to wait for the stock to trade below the intrinsic value. You need to assess if the company has sound fundamentals at the time you buy it.

• Technical analysis

With this investment style, you analyze the daily, weekly or even hourly or minute-by-minute move of the stocks. You try to detect a pattern that will predict the price move over the coming minutes, hours days or weeks. It requires the discipline to cut wrong buys and to let winners run.

• Index investor

An index investors uses a series of low cost index funds (trackers) to follow in a passive way the market returns. This is usually done by people that want a “lazy” approach for investing. This is an investment style that can be easily automated. The idea is that having the stock market average return is better than most active investors.

• Active managed funds

This is similar to index investing: only, you do  to buy a set of trackers, but you buy a series of active managed funds. For a starter, I believe it is best to start with mixed funds: this are funds that that can invest in stocks, bonds, cash, … You have the fund manager doing the heavy lifting.

Asset allocation for your risk profile

You need to find out for yourself how much risk (volatility, pare loss, drawdown) you want in your portfolio. It can be very complex, but comes down to the following question: how good will you sleep if your portfolio is worth less than you paid for?

It seems a simple question, but research shows that people overestimate their risk tolerance. People also are more risk tolerant when the markets are going up.

Some rule of thumbs to translate risk tolerance into an asset allocation

• keep 100 – your age in stocks
• use a table that translates a max loss you want into an asset allocation

follow up

Once you start investing, you need to follow up your investments. Some investments style need more follow up than others. But all styles need some basic tracking of your progress and a rebalancing of your asset allocation.

Good luck with your investing adventures.