The REAL First Step to Becoming a Successful Investor

The number one question I am asked when it comes to investing is … where do I start?

What’s the first step?

And it’s funny because even now, when I sit down to work on one of my portfolios, I often find that the all-important question “where do I begin” is still extremely relevant, even at more advanced levels of investing.

In fact, the question of where to begin might be even more relevant the more advanced you become as an investor.

Stop me if any of these questions sound familiar.

Should I be scanning stocks?

Will ETFs help shore up my strategy? Do I need to hedge?

Should I be looking at a new asset allocation strategy? Should I be researching macro-economic trends? Do I need to look at inflation patterns over the last twelve months? Consumer confidence levels? The strength of the US dollar? The strength of other currencies?

Should I learn how to use options? What should I do first?

Where do I begin?

It Can Feel Like a Lot. Start Here.

I feel your pain, my friends. And one thing I want to tell you right away is this: choosing somewhere to start that’s good (if not perfect) is a million times better than doing nothing and wringing your hands with indecision.

Don’t give up. You’ll get where you need to be.

So let’s talk about where you are right now, a pure beginner.

Many people think that the first step is opening a brokerage account, or researching stocks, or reading a beginner’s guide to investing like the Investing QuickStart Guide.

All of those are important steps, but they aren’t the true first step.

While it is a fact that you can get started investing with very little money, the true first step to a successful investing journey is …

Getting your own personal financial house in order.

That might not be what you want to hear, but aside from educating yourself, nothing is more important than starting from a position of financial strength.

To be clear, financial strength doesn’t mean being independently wealthy.

But it does mean that you are a master of your financial domain.

You are not spending more than you are earning. You are not paying for goods and services you don’t use. You are not overpaying for goods and services that can be found at similar quality for a lower price.

You have capital!

A Quick Aside about Capital

One of the biggest, most important realizations I’ve had since beginning my own investing journey is coming to terms with the true meaning of the word “capital.”

It never really hit me, the simple difference between “capital” and “money,” until one day when I was reading one of Warren Buffett’s famous “letters to the shareholders of Berkshire Hathaway.”

These letters are published going back decades and they are fascinating.

Buffett was praising the managers of the companies owned by Berkshire and stating how he and his business partners pretty much just tried to stay out of their way.

As far as Buffett was concerned, his job was not to oversee the managers but simply to allocate capital properly.

It struck me all of a sudden how the use of “capital” exists quite separately from the use of “money.”

  • Money is used by people and businesses: to pay their bills and their employees, to account for the revenues they take in, to power their checking accounts.
  • Capital, on the other hand, is simply the money left over that can be allocated toward judicious investments in hope of making a return. All capital is money, but all money is certainly not capital.

Capital is the excess.

And Buffett has become insanely successful as an investor by managing this excess with the same degree of care and precision as you’d find in a CEO managing a successful car company, or a small business owner managing a successful donut shop, or a head of household managing a family budget.

You may have capital.

It may be sitting in an IRA or in another brokerage account. And the odds are that you would like to generate more. Well, at the end of the day, an investor’s talent is in his ability to manage money—to expertly allocate capital.

You need to start at your own financial front door.

Start by Putting Your Financial House in Order

This is a guiding principle that I have come to believe in strongly. It may seem a little odd, out of context—why does my personal budget have anything to do with my ability to pick good stocks?—but I assure you there are important logistical and psychological reasons for this approach.

When your personal financial house is in order you can do the following:

  • Invest with a higher degree of flexibility
  • Act out of rationality instead of fear
  • Afford to be more patient with your investments
  • Avoid significant amounts of investment-related stress
  • Be proactive instead of reactive
  • And the list goes on …

Here’s the bottom line:

If nothing else, you should possess a strong sense of financial awareness (if not control) before investing.

You don’t have to be 100 percent debt free with a rock-solid budget that you’ve adhered to religiously for ten months.

But you should at least understand your personal finances and how they can be managed effectively: if you used your capital to pay down your debt, what would be your equivalent return relative to a stock that returned 7 percent?

Do you know the answer to that question?

Because if you don’t, then you definitely have some work to do—and that’s okay.

Why Personal Finance?

Personal finance is important whether or not you are beginning your investing journey. The problem is, good personal finance habits are something you likely never learned in school.

This topic is simply not part of our traditional school education.

Why this is or isn’t the case is an entirely separate conversation, but the point is that most of us have been left to figure it out on our own.

What follows is a list of personal finance objectives straight out of my Investing QuickStart Course.

If you are already practicing sound personal finance principles, congratulations! You’re ahead of the game.

If some (or many) of the items on this list don’t describe you, that’s okay.

The bad news is that you have some work ahead of you. The good news is that no matter your financial situation, it is possible to put yourself on track.

Seriously.

If you aren’t happy with your current financial situation, you can get back on track.

Take a look at the list below and think about how many of these best practices apply to your financial life.

Budget
Know exactly where your money is going each month. Knowledge is power.

Pay down bad debt
High-interest credit card debt, personal loans, and other consumer debt should be paid off as soon as possible.

This, more than any other action you can take, will help put you on the right path. I am not kidding.

Work toward eliminating the payments associated with debt and the interest associated with consumer debt.

It may not feel like you are making headway, but diluting and ultimately eliminating this financial burden will free up your cash flow and help you move toward total financial independence.

I know that when I think of not having to pay a mortgage or student loans, my mind instantly rushes to thoughts of how much I’d love to find a better way to allocate that capital.

Maybe I’d shore up my position in emerging market equities or finally do that long-term macro analysis of the materials sector that I’ve been putting off because (even though I’m confident I could do it well) it’s complex and all my money is tied up in other investments.

Pssst. Are you beginning to see how your personal financial concerns logically and inevitably intersect with your investment concerns?

Live below your means
Don’t spend every single dollar you make; be conservative with your spending, and think about the future.

Pay yourself first
Automatically set aside 10 percent of your income for savings/investing.

After you reach an emergency savings amount, invest the rest. The farther below your means you live, the more money you will have to prepare for the future and to put to work in the market.

Prepare for emergencies
Have an emergency fund at hand. I know you want to hear about how to put your money to work, but an unplanned emergency can wipe you out if you don’t have a cushion.

Liquid (easily accessible) cash for three months of expenses is a good start. Enough cash for six months to a year of expenses is better.

Max out your 401K employer matching contribution
There may not be such a thing as a free lunch, but employer matching contribution programs amount to essentially free money.

It’s usually a 100 percent return on a certain portion of your paycheck. As you will soon learn, investors would gladly give their left eye for a guaranteed 100 percent return.

You must take advantage of this.

Work on steadily improving your credit
This doesn’t directly help with your investment success goals, but it does give you more options when it comes to larger purchases, and it can mean lower interest rates.

More options and less debt translate into more control over your financial situation.

Invest, invest, invest
Money that isn’t working for you is being slowly devalued by inflation.

Money that sits in your checking account will be spent.

Money that sits in your savings account isn’t really saved; it’s simply “deferred spending.”

This doesn’t include your emergency fund. That money needs to be kept close and accessible. But anything past an emergency fund in your savings account isn’t working as hard as it could be.

Invest, invest, invest.

The Bottom Line

With a command of your financial situation you can invest with confidence, without fear, and from a position of strength—even if you only have a little to get started with.

While it is technically true that the personal finance principles I have just outlined aren’t prerequisites to investing success, they remove a considerable amount of stress from the prospect of using the market to grow your wealth.

Furthermore, investing aside, there is a considerable peace of mind that comes from taking control of your finances. If that is a goal that seems out of reach for you right now, know this one simple fact: it is never too late to bring your finances under control and to put your financial house in order.

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