Hopefully you’ve read article 1 all about why we think starting investing early is a smart move (if you haven’t, click previous post at the bottom of the page) and you’re eager to dive in! Or perhaps you’ve skipped that and you want to get to the good stuff.
But hold up there son, an even smarter thing to do would be to get your affairs in order beforehand. This way, you can invest safe in the knowledge that all of the important aspects of your finances are taken care of. Doing these things will also give your investments the best chance to thrive! So without further ado, let’s get going!
#1 – Make a budget
I’d like to think that you already have some sort of budget to manage your household income and outgoings (if not, this is your chance!) but if we’re going to consider investing, we need to get serious about it. Most people have some sort of budget but you’d be surprised how many people don’t know how much their mortgage payments are, how much their utilities are costing them and some don’t even know exactly how much they earn per month! As you’re probably aware, investing in itself is a risk. You see the notices on investing websites or platforms – “capital at risk” and this is true (though later in the series we talk about how to manage this). So before I invest, I need to be absolutely sure that my essentials, like food, shelter, water etc are covered and that I can comfortably invest my surplus. That means knowing exactly how much is coming in and going out, making sure I know exactly where every pound is going.
There are literally hundreds of budgeting templates out there on the interwebs. However, I like to keep things as simple as possible. My budget is an excel spreadsheet on my phone that is split into 4 parts – income, joint outgoings, my personal outgoings, my wife’s personal outgoings (I do the finances for the whole household). In income, I list any monies coming into our accounts, whether that’s from business, a job, the government etc. The joint outgoings includes all of the household bills and monies toward child costs. This even includes our food shopping budget for the month and any potential additional expenses that month (the car needs tyres, or the kids need shoes etc). Our personal outgoings include all expenses specific to each of us like any memberships etc but also includes our monthly pocket money and fuel budget for travel (yes, we give ourselves pocket money!). I subtract the total outgoings from the income and whatever left is free and available for investing! The great thing is, because I know exactly where each pound is going, its easy for me to see where I can cut costs, thus giving me more money to invest!
#2 – Stop wasting money
But what if when you subtract the outgoings from the income and you get a NEGATIVE number? In that case my friend, you are living beyond your means. Or your means don’t satisfy your life. Or both. Even if that number isn’t negative, if its too little, building a decent portfolio is going to be a struggle. We need to crank those numbers up, FAST.
One thing you can do is to increase your earnings to outstrip your expenses. While this is a great move, an even better one is to learn to curb your expenses first. The reason for this is, if you don’t learn to control your spending, your expenses will likely rise to match your new earnings, as is the case with almost everyone. Plus, cutting your spending can be done easily and quickly. Win win!
“Beware of little expenses. A small leak will sink a great ship”– Benjamin Franklin
Could you do without that Starbucks every day on your way to work? Do you need Disney+, Netflix and Amazon prime? When was the last time you used your gym membership? These might all sound trivial but can really make a difference to your balance sheet. That’s without looking at some of the bigger costs. Could you re-mortgage for a better deal or even downsize? Do you need a brand new car every 4 years? How far can you slash your food bill for the month by shopping differently? When all said and done, we think the average household can save hundreds by doing this ‘money makeover’. With that new spare cash, you can then…..not invest it, move into number 3, which is…
#3 – Clear Debt – The shortest route to your goal is debt free
That’s right. Even when there’s spare cash to invest, we’re not out of the woods. This part is an extremely important (and frankly obvious) part and I’m always baffled to find people who regularly invest and also regularly rack up debt! The shortest route to financial freedom is debt free.
Good debt vs bad debt
I should probably explain at this point the difference between good debt and bad debt. You’ve probably heard about good and bad debt before in some form but I like to be crystal clear on this. ‘Good debt’ in our book is a mortgage as long as you can comfortably afford the payments (especially if the interest rate is lower than 3% or you’re using it to leverage, more on that in a different article) and student loan debt (which is basically more like a tax than a loan, though not having it would still be preferable). That’s it. Obviously that’s not definitive and you may have examples of ‘credit’ which you believe to be OK. But credit cards, loans, any kind of retail credit, cars, bank charges or any other kind of debt is bad debt in our book.
The reason is simple; debt usually carries interest. The same way that we explained compound interest in article 1, the banks can do the same to you in reverse. A small loan can quickly become difficult to pay off due to interest and if something unexpected hits your finances and you’re unable to pay, the payments can rocket, or worse yet, you’re forced to take out more credit to get by! That’s why its so easy for debt to spiral out of control.
The good news is, the benefit of paying off debt is two fold!
First, paying off debt is just like making returns on an investment! Have a £1000 credit card balance that will incur a 15% charge? Pay it off and you’ve just invested £1000 and made a 15% return. Nice. Got a personal loan charging 11%? Pay it off early and you’ve just made 11% on the money you put in.
The second is that clearing your debts will free up even more cash every month to clear even more debt and so on until there’s no more debt to go at! Happy days!
When I cleared my debt, I started with the most expensive debt first (highest interest rate) and worked back from there until I paid off my last credit card, which although was on a 0% rate, was still bad debt (yes, even 0% deals we consider bad debt as although these deals can help people get out of worsening debt, still have the potential to cause issues if you miss a minimum payment, can’t pay it off by the end of the 0% period or struggle to switch to a new deal).
#4 – Build an emergency fund
When we started this financial makeover, we were really keen to overlook this part. I thought to myself “what good is a lump of money sitting in my bank account when it could be earning me money in the stock market”. However, it was only when we started investing we realised how volatile the stock market could be (Covid pandemic anyone?). Temporary dips (or crashes) in the stock market like this can dramatically impact on your funds – and this tends to happen right when you need those funds the most! Case in point, let’s say you were told you were losing your job due to a pandemic. On top of that, the boiler in the house breaks down. You may need to access some emergency funds right? Well too bad, because all of your funds are in the stock market, which has crashed due to the pandemic.
OK you’ve made your point, so how much should I put aside?
Of course, everyone’s situation is different. If you’ve got lots of different income streams or have skills that are easily transferable to different jobs, you may want a smaller fund. If you have a real niche job, you may want a larger one. In real terms, you should ideally have enough put aside to cover your regular monthly expenses for as long as you think you’ll need to get back on your feet should the worst happen. We personally only keep 3 real months expenses set aside, though we keep an additional 3-6 months on top of that in case a great investing opportunity comes along, which usually comes along in crisis times (more on that in a different article). Never let this sum of money dip below 3 months worth though.
The good news is, we’ve already cut our monthly expenses in step 2, so it should take less time to accumulate this sum! Nice!
#5 – Make a plan and commit
There’s no two ways about it, achieving financial success takes serious drive and commitment (if it didn’t, everyone would be killing it right?). Just implementing these 5 steps alone is a tough thing in it’s self. With enough work though, it should be achievable for most people.
Treat it like the gym
The real challenge though, is keeping this up for the next however many years, staying consistent and keeping the faith. Think of it like the gym. Would you expect to build rock hard abs or be able to run a marathon of you didn’t train, get your diet in check and maintain it until you reach your goal? Of course not and your finances should be treated in exactly the same way. Like the gym, it’s the early stages that are the hardest to get through too. In the early days, it can be demoralising not seeing the results you want immediately even though you’ve worked your socks off. In the money world, this could be your investment pot taking a dip, or seeing just a very small return initially. On top of that, there are so many things sent to test us. The sirens call of a takeaway meal can set your fitness goals back. The call of that shiny new BMW will do the same thing to your financial freedom. Curb it and your chances of success improve.
Make a plan
“A dream written down with a date becomes a goal. A goal broken down into steps becomes a plan. A plan backed by action makes your dreams come true”– Greg S Reid
Mapping a journey before you take it is the best way to reach your destination. Fail to do this can cause delays, get you lost or worse yet miss your goals entirely.
Later in this series we talk about exactly how you can calculate how much cash you’ll need if retiring early is your goal but for now, getting a goal in mind and mapping out the broad steps to achieve it will help focus your attention on what priorities you should be working on. Your goal might be to cut your working hours, retire early, earn enough to purchase real estate. Whatever your goal, fashioning a plan will break your goal down in to bite size milestones that you can tackle far easier than trying to reach the top of the mountain on day one.
For reference, our broad plan looked something like this:
Goal: Retire in 40s whilst maintaining current income
Plan: Money Makeover > Invest the difference each month > Start a side business > build enough to invest in rental property > continue with all 3 avenues until portfolio worth 1M+ > Extract 5% annually and retire
As you can see, there’s not too much detail at this point and the plan is intentionally simple but gives a road map to build on with a clear method and an end goal. You can then add detail around each of these steps like how much to invest, how much the first rental property would be, how much additional money you should aim to bring in through a side business etc.
#6 – BONUS! Other worthwhile things to consider
Firstly, well done for making it this far. I appreciate that this is a particularly lengthy step but hopefully you’ve found some value in it. We’d like to finish with some other worthwhile things to consider before you invest. Not all of these will apply and we won’t go into great detail but they can be some great tools in your money making arsenal:
- Max out your workplace pension – some employers run pension schemes where they match any contributions you put in from your wages (some even contribute more!). If your workplace runs one of these schemes, even though that pension is probably poorly invested (in our opinion, most are), you’re getting 100% return before you even start, so it’s worth capitalising on this.
- Get your spouse / family on board – people who start investing usually forget this one but can it become a thorn in the side very early on if you don’t do this. If your better half was planning on buying that new *insert meaningless thing here* with that money that you just invested, they’re probably not going to be best pleased if you haven’t talked it over. Couples who save together, stay together. You will dramatically improve your chance of reaching your goals if they are aligned.
- Make your net worth your measuring stick – most people measure their success by how much they earn per year. While this is useful to see what you can afford, without that job, they’re more often than not worth very little. If your goal is to retire early / do what you want, measuring your success by net worth can really help frame things properly. Who’s richer, the guy who earns 100k who spends every penny and has no assets, or the lady earning 30k from a portfolio of assets who doesn’t have any bills to pay at all?
Thanks for reading! Click on ‘next post’ below for the next instalment of our wealth building guide.
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