Investing is an important part of a healthy financial life. You want your money to grow, and, short of winning the lottery, investing is the best way to do that. But as Jonathan Clements, the editor of Humble Dollar, reminds us in his newsletter, it's hardly the only thing that matters.
Conventional wisdom: Investing is where the big money is made. Reality: While our investment performance is a big potential contributor to our wealth, we'll likely help our financial situation far more if we devote our energies to improving other areas of our financial lives. That means minimising our borrowing costs, holding down insurance premiums, buying the right-size home, raising money-smart kids - and, most important, saving diligently.
A lot of financial content emphasises investments, and of course you should invest early and consistently. But Clements' point gets at something larger in the personal finance sphere: Money websites and personalities talk about investing products and strategies because that makes them a lot of money. It can be overemphasised. It's great to be curious and find new ways to invest; you can do what you want with your money. But for many people, getting in on the ground floor of some hot new company or strategy is not what is making or breaking their day-to-day. To have sound finances you have to pay attention to the entire picture.
Speaking of which, he continues:
Conventional wisdom: There's retirement, insurance, college, houses, estate planning and more. Reality: All these things are connected. Our financial lives are a battleground of competing demands, with a broad array of expenses and goals laying claim to our limited income and assets. To make smart decisions about our money - including how much to save, what portfolio to hold, what goals to pursue, what insurance to buy and how much debt is prudent - we need to look at our overall financial picture.
Often, the key organising principle is our human capital - our income-earning ability - or the lack thereof. As I discussed in an earlier newsletter, our regular paycheck drives our insurance needs, allows us to take on debt, provides the savings needed for retirement and frees us up to invest in stocks.
Investing is important, as are your health insurance costs, as is your paycheck, as is paying off debt with a higher interest rate than what the market is returning. You can't count on investing alone to keep you afloat later in life - your income and savings (and luck) are big parts of that, too. If you want more money you need to earn more money, and you need to save it. The more you save, the bigger potential return you can get from investing (you know, it takes money to make money). More on that:
And if you want to invest to earn a bigger return over time, then what to do is pretty clear. Invest in low-cost, diversified indexed mutual funds and exchange-traded funds. Avoid actively-managed funds. It isn't sexy. In fact it's really boring, but it's what works:
Conventional wisdom: If we want higher returns, we need to pick market-beating stocks, bonds and mutual funds. Reality: If we want higher returns, we should forget trying to outguess the market - and instead focus on taking sensible risk, holding down investment costs and minimising taxes. That brings us back to indexing. But it also means settling on the right asset allocation and diversification strategy, maxing out our retirement accounts and buying tax-efficient investments in our taxable accounts. These are all aspects of our investment strategy that are entirely within our control - and where a little effort can pay big dividends.
If you invest because you want to be rich, then, as Clements writes, you'll never have enough. Instead, focus on the life you want to lead and what you need to achieve that.