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The Motley Fool has been helping ordinary people become better investors for nearly two decades. This month, we're reaching out to millions of investors to help guide them in their quest toward financial knowledge and independence.
During the last few weeks, I've looked at several different aspects of investing, ranging from making your cash work harder for you to getting acquainted with some of the stocks and funds that give you lucrative opportunities to profit in the long run.
Yet when you take a step back from all those specific investments, you need a unified financial strategy to guide you in choosing among them and allocating your money appropriately. Although experienced investors often follow complex strategies, starting out simple is always helpful. So with that in mind, here's a five-step plan you can follow to get your finances in order and get on the road to prosperity and financial security.
Step 1: Get out of the red.
Lots of beginning investors often want to dive into stocks right away. But if you've got balances on high-interest credit cards or other costly debt, use most of your spare cash to get it paid down.
Granted, there are occasions when it would be smarter to invest than to pay off debt. For instance, credit-card-issuing banks JPMorgan Chase (NYSE: JPM ) , Citigroup (NYSE: C ) , and Bank of America (NYSE: BAC ) have all posted returns in the 25% to 40% range in the past year, beating all but the costliest of credit card rates. But usually, you'll end up better off saving yourself interest charges of 15% to 20% or more.
Step 2: Build a cash cushion.
Even once you're out of debt, you want to make sure you stay that way. Having an emergency fund to cover unexpected expenses is a big step toward protecting yourself from a financial catastrophe that can undo all your progress in fighting your debt. Most experts advise three to six months' worth of expenses to help you weather a layoff, but even having just a few hundred dollars can prevent you from having to go back into debt to cover a car repair or a broken water pipe.
Step 3: Take the free money.
Once you're ready to invest, make investments where you'll get some extra help. With an employer-sponsored retirement plan like a 401(k), your employer may match your savings with extra money, so make sure you take advantage of it. Even though they temporarily cut their 401(k) matching during the recession, Ford (NYSE: F ) and Weyerhaeuser (NYSE: WY ) were just a couple of the many employers who restored matching when the economy improved.
Similarly, IRAs and 401(k)s can cut your tax liability and make you eligible for tax credits. Money you contribute to traditional retirement accounts is excluded from your income. If you qualify for the Saver's Credit, you can earn as much as $1,000 in tax savings for contributing as little as $2,000 to an IRA or 401(k). Get more information from the IRS by clicking here.
Step 4: Build a core portfolio.
Some investors feel comfortable starting with individual stocks and never look back. But for most beginners, mutual funds and ETFs are an easier, less scary place to start.
In particular, low-cost index funds and ETFs make it simple to get broad market exposure in a variety of different types of investments. Target retirement funds even combine different investments in a single fund, automatically changing their allocation among stocks, bonds, and cash as you get older to make their overall portfolio more conservative. Whether you go that route or choose to build your own mix of funds and ETFs, following simple asset allocation methods to build a core portfolio is a great way to start.
Step 5: Pepper in some stock picks.
Once you have core holdings established, it's easier to take the greater risk of making specialized investment plays. You may pick individual stocks, or you might prefer to use sector ETFs or other niche investments to capture returns from a group of stocks. As you gain confidence, you can devote more of your money toward this part of your portfolio, leaving your core untouched to grow more conservatively.
Get started today
Whether you've never thought of investing before or have been trying to get up the nerve to start for years, now's the perfect time to take action.
In fact, we want to help. Let me take this final opportunity to urge you to look at the special website we've set up at InvestBetterDay.com. Tomorrow, Sept. 25, we're taking a day to celebrate the art of investing, and we encourage your participation. Take a look at the site now and get on the path to personal prosperity.
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