So, how do I start investing?
Great question. The first thing to do is to stop going backward. PAY OFF YOUR CREDIT CARD DEBT. Credit card debt can cost 15% a year, 20% a year, or even more. So, pay off your credit card debt as soon as possible, before thinking about investing anywhere else.
Next, start saving and investing. How can you do that? Spend less than you make. Put aside a set percentage, hopefully at least 10% of what you earn. That’s the secret. It may be hard, but as Benjamin Franklin shared in The Way to Wealth, “If you know how to spend less than you get, you have the philosopher’s stone.”
Or as Charles Dickens shared in David Copperfield,
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness.
Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”
Updated by Warren Buffett’s partner, Charlie Munger, “Spend less than you make; always be saving something. Put it into a tax-deferred account. Over time, it will begin to amount to something. This is such a no-brainer.”
What did Munger mean by a “tax-deferred” account? Of course, there are a number of retirement accounts that most people already know about.
You can put up to $6,000 a year into an IRA (an Individual Retirement Account) or your company may offer you the ability to invest in a 401K account. These accounts let you invest money for your retirement in a very tax efficient way. Some employers even match a certain percentage of your 401k contributions that can supercharge your own contributions. In general, you can invest this money on a pre-tax basis (before your earnings are taxed by the government). The money can then compound tax free until retirement (and we already know how powerful compounding, especially tax-free compounding, can be).
However, one thing to keep in mind for IRA and 401k retirement accounts is that, in most cases, this money isn’t available until you retire without having to pay early withdrawal penalties. In addition, even when money is taken out upon retirement, it is generally taxed at ordinary income tax rates, which are generally higher than long-term capital gains tax rates.
So, an additional choice is to invest in a tax efficient index ETF (Exchange Traded Fund). For most well-run index ETFs, taxes are only owed on any dividends received; dividends are usually taxed at attractive tax rates. No other taxes are owed by the holder of an ETF until the ETF is sold, perhaps 10, 20 or 30 years later–and even when taxed, those gains would be taxed at attractive long-term capital gains tax rates. Once again, providing the opportunity for “tax-deferred” compounding (your earnings can accumulate capital gains tax-free until the ETF is sold), but with ETFs as opposed to IRAs and 401ks, there is no penalty for early withdrawal.
In short, there are lots of smart ways to get started!
Glossary of Terms
Tax-deferred earnings accumulate tax-free until the investor takes receipt of the profits.
An Individual Retirement Account (IRA) is one of the most common types of tax-deferred investments. An IRA allows participants to claim some or all of their contributions as a deduction on their tax return.
A 401k plan is a tax-deferred contribution account offered by employers to help grow employees’ retirement savings.
ETFs are a collection of securities—such as stocks—that are bought and sold throughout the day on stock exchanges.
Capital gains are the profit realized on the sale of a non-inventory asset such as the sale of stocks, bonds, precious metals, real estate, and property.