Reaching Your Long-Term Investment Goals: Get Started with a Roadmap

You are interested in a Long-Term Investment Strategy but not sure where to start. Good! This is for you. Throughout the journey of our professional careers, we will encounter many major decisions, some of which we are more prepared for than others. Depending on your background and interests, you may understand that you need a plan for long-term investment goals, but do not know where to start. If so, know that you’re not alone. To build confidence in your plan, it is important to understand that building wealth through a long-term investment strategy is a journey with many options, detours, and pitfalls, but that the destination and milestones along the way are well worth it. I’ll begin here with some basics.

Four Basic Steps to Get You Started

Step 1: Get Your Everyday Finances in Order

If you want to appropriately allocate your liquid assets into a long-term investment strategy, you must first do a thorough audit of your personal assets and liabilities.

Create a basic budget: Write down all of your financial inflows and outflows. What is your monthly after-tax income? What are your monthly fixed expenses? What are your monthly variable expenses (hobbies, travel, restaurants)? How much do you save? The act of recording these items may seem simplistic, but seeing each line item on paper (or in a spreadsheet) helps internalize your finances and create a repeatable benchmark and habit. Though it may be convenient to quickly glance at a bank account balance, the few seconds spent here do not offer the same benefit you get from thoroughly recording your full budgetary picture. Setting aside time to focus on this on a regular basis will create better awareness of your overall spending picture.

When composing a budget, complete a thorough review of each line item. Are there any expense items that seem excessive? If you see expenses worth addressing, consider setting a short-term goal for yourself, such as “I will only dine out for two meals this week.” These small, attainable goals can create accountability, make you aware of bad spending habits, and help create favorable savings habits for the long run.

One mistake young professionals often make is stretching the budget to buy cars. Cars are depreciating assets, put additional strain on your monthly budget, and require higher insurance and ongoing maintenance costs.1

Pay off Credit Card Debts: This point cannot be emphasized enough…pay off any credit card debt. Do it. Having thousands of dollars of credit card debt, whether accrued for legitimate reasons or through youthful oversight, wreaks havoc on financial plans. Many credit cards offer low introductory rates, and then increase drastically after a few months or years. That increase can compound debts rapidly and it can be difficult to earn a higher rate with investments than the high rates charged on credit card debt.

Protect Yourself with Insurance and Emergency Savings: Nothing can disrupt your financial plan more drastically than an unexpected event, whether it is a health emergency or the loss of a job. Review your insurance policies for adequate coverage, and make sure that your employer-provided insurance covers medical needs. Beyond insurance policies, begin funding an emergency savings account – a good rule of thumb is to keep a stable source of funds that can cover six months of expenses.

Experiment with a Retirement Calculator: This exercise only takes a few minutes and requires a few high-level questions about your current financial status such as age, investment comfort style, planned annual savings, planned retirement age, etc. I recommend running and experimenting with the inputs while you are young, to stress test the impact of how those decisions influence your finances over the long-term. For example, you can see the results if you input a retirement age of 50, then age 65, or the benefit of increasing your savings rates. It is also a good practice to review this every few years to track progress. Use of these calculators will help answer a few common questions: How much do you need to save per year to reach a certain savings goal? Or, if you can only save a certain dollar amount each year, when can you afford to retire?

There are more detailed planning tools out there, but I like this simple calculator provided by Charles Schwab, which you can find here.

Step 2: Work on Maximizing Your Contributions to Common Retirement Vehicles

Once your day-to-day finances are on sound footing, proceed with contributions to basic savings funds and retirement vehicles. Two of the most standard are 401(k) plans and Roth IRAs:

401(k) Plans: 401(k) plans are employer-sponsored, defined contribution plans that have largely replaced pension plans (defined benefit plans) in the workforce, offering employees the option to set aside part of each paycheck towards an investment account and select the investments to match your time horizon. 401(k) plans grow tax-deferred until distributions are made during retirement (distributions cannot begin until after you turn 59 ½). In addition, your taxable income is reduced by your pre-tax 401(k) contributions. You should note, however, that maxing out your 401(k) annual contribution is likely not enough to meet your future goals. Your investment options are typically selected by your provider and employer, and may be limited.

Another benefit to 401(k) plans is that many offer employer matching policies. Most employers will match up to a certain percentage. At the very least, you should attempt to contribute at a level that will earn the full employer match. Doing any less will mean that you’re missing out on one of the few free lunches in life.

While it is ideal to fund your 401(k) account to the maximum annual limit (currently $18,000), that could be an unrealistic ambition for some, especially when also saving in other ways.

Roth IRAs: Roth IRAs are savings vehicles designed to be funded with post-tax dollars, meaning there is no up-front tax deduction. However, the primary value of Roth IRAs is that all contributions and growth can be distributed tax-free once retirement age is reached. These features offer a huge upside to younger investors with a long time horizon and anticipate wage growth over the course of their careers. The maximum annual contribution to a Roth IRA is currently $5,500, and I encourage the maximum contribution whenever possible (note: those with high income may not qualify).

In a Roth IRA, you have access to a full array of investment options including stocks, bonds, ETFs and mutual funds. Similar to brokerage accounts (see below), you can easily open these accounts at custodians such as Schwab, Fidelity or Vanguard.

If your income is too high for a Roth IRA, you can consider non-deductible IRA contributions. Just make sure to file IRS Form 8606 with your taxes to capture the contribution each year. When the time arrives to take IRA distributions, you do not have to pay taxes on your contributions that were non-deductible.

Step 3: Open a Brokerage Account for Investing Other Discretionary Funds

With your financial situation in order and basic investment vehicles funded, you should strongly consider opening a brokerage account at a custodial firm like Schwab, Fidelity or Vanguard. A brokerage account can be opened either online or through an advisor, and offers a full array of investment options similar to a Roth IRA.

However you choose to invest this account, and regardless of how much you put into these accounts, align your investments to work in tandem with your goals and other assets you may have in your 401(k) or Roth IRA accounts. For example, ETFs are often more tax-efficient than mutual funds, so one idea is to hold ETFs in your brokerage accounts and less tax-efficient strategies in your 401(k) and Roth IRA.

Step 4: Automate Your Contributions

If you are one to manually contribute to your brokerage account each pay period or month, great! If you are one of the other 98% of the population, you should consider applying technology to automatically transfer a certain dollar amount (or percentage) from your checking account to your brokerage account. If you have a month when you have a surplus in your checking account, a best practice is to manually transfer excess funds to your brokerage account. Note that unlike retirement accounts, there is no maximum contribution amount for these brokerage accounts!

Revisit Your Long-Term Strategy Periodically

If you have gone through the steps outlined above – your budget is clear, you have a ballpark idea for how much you plan to save per year, your debts are being handled, you’ve maximized retirement contributions, you’re investing additional discretionary income – then check in periodically to ensure everything adheres to one cohesive investment strategy. Remember this plan works best when you are goal-oriented. What uses do you plan for these investments? A new house? A child’s future education? A vacation home?

Long-term investment strategies vary, but all require patience. These strategies are called long-term for a reason, in that investments can be very volatile and frustrating over short-term time periods, but over the long-term (10+ years) a sound investment strategy with patience and discipline should result in compounded growth to help reach your goals. Keep one relevant Warren Buffett quote in mind: “the stock market is an efficient device for transferring wealth from the impatient to the patient.”

You should also avoid the assumption that once you’ve begun a long-term investment plan, you can sit back, relax, and watch your money accumulate until you’re ready to retire. In reality, the strongest long-term investment planning is dynamic and adjusts to life events. Even though your long-term financial goals for retirement may stay the same, the circumstances of your life are likely to change as you pass through various life stages.  It is important to revisit periodically to make sure that your portfolio reflects your goals. If short-term needs arise (such as a down payment for a new home) it is wise to plan to avoid the chance of a market correction from adversely impacting any short-term goals.

Consider a Financial Adviser to Guide You Through Your Investment Decisions

As you begin exploring your long-term financial opportunities, the different options could seem overwhelming. In those instances, consider including a financial advisor in your strategy. Creating the right investment strategy for you is a dynamic process that requires planning and a lot of patience. Your financial advisor can help you optimize that process so that your efforts keep you on the road toward reaching your goals, and enjoying the journey along the way.

 

1 Read more on budgeting and other skills for millennials to master now on our blog: Three Financial Skills Millennials Can Master Now
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Tim Hughes, CFP®

Tim is a managing director and serves as head of our Reston, Virginia office.