Getting Started With Investing in 7 Steps

Victor Gersten, EA, CFP®, MS, MPAS™

Investing intimidates a lot of people. The reason is usually not the mathematics. It is that the first decisions get made in the wrong order. The portfolio then ends up carrying weight it was never designed to bear.

What follows is the sequence I use. Each step depends on the one before it. Skipping ahead is the most common reason a plan fails later. This is general information rather than advice about your own situation.

Step 1: Identify the goal

What is the money for? Retirement, a house, a child’s education and a sabbatical are different problems. They call for different answers.

Set a few goals rather than one. The more specific each goal is, the easier every later decision becomes. A vague goal cannot tell you whether a portfolio is appropriate.

Step 2: Attach a time horizon

Every goal needs a date. In planning terms, horizons fall into three groups. Short term means up to three years. Medium term means three to ten years. Long term means ten years or more.

The horizon does most of the work in choosing investments. Money needed in two years and money needed in twenty are not the same money. Treating them alike is how people end up selling at the worst moment.

Step 3: Understand your cash flow

Before you decide what to invest in, work out what you can actually invest. That means knowing what is left after expenses and debt payments. Measure the number rather than estimating it.

This step is unglamorous. It is also where I most often find money that was not doing anything useful. Move on only once you know what you have available for each goal.

Step 4: Size your emergency fund

Set money aside before any of it goes into a long-term portfolio. You want enough to cover a stop in income or an unexpected expense.

The common advice is three to six months of expenses. Treat that as a starting point rather than an answer. The right figure depends on how stable your income is. It also depends on whether you own a home, whether anyone depends on you, and how quickly you could replace your work.

Step 5: Establish your real risk tolerance

This is the step that decides whether the plan survives.

The question is not what allocation the arithmetic recommends. It is what allocation you will still hold after a bad year. Those are different questions, and the second one matters more.

The most expensive mistake in investing is not a suboptimal allocation. It is selling after a decline and never coming back.

A long horizon and a stable income might argue for an aggressive portfolio. Yet you may know from experience that a large drawdown will keep you awake. In that case the technically optimal answer is not the right one for you. An adviser who assigns you a risk tolerance, rather than establishing it, is setting up a failure that surfaces years later.

Step 6: Choose the right type of account

Taxable, tax-deferred and tax-free accounts each work differently. They have their own contribution limits, withdrawal rules and tax treatment.

Which account holds which asset affects your eventual return more than most people expect. The decision is also easier to make correctly at the start than to correct later.

Pay attention to fees at this stage too. Account maintenance and transaction costs come directly off your return every year.

Step 7: Invest, and diversify properly

Only now does the investment selection itself arrive. By this point most of the important decisions have already been made.

Diversification means spreading across asset classes. Those are mainly equities, fixed income, cash and alternatives. Then you spread within them, across geography, company size and sector.

A portfolio concentrated in whatever performed best last year is not diversified, whatever it holds. The instinct to chase a single asset is exactly what this sequence protects you against. That applies to a hot stock, to gold and to cryptocurrency alike.

If You Live Outside the United States, Two Steps Change

This sequence assumes a US account and a US address. If you live abroad, or expect to, steps 6 and 7 work differently. Those differences are expensive to discover late.

Step 6 changes

Some US institutions restrict or close accounts once the address of record becomes foreign. So confirm your custodian’s policy in writing before you change the address. Why US Brokerages Are Closing Expat Accounts, and What to Do About It covers what to do if a notice arrives.

Step 7 changes

The funds sold locally in Europe are generally passive foreign investment companies for US tax purposes. That brings a punitive default regime and a separate filing for each holding. Meanwhile EU rules restrict the sale of US-domiciled ETFs to retail investors resident in the EU. You are therefore constrained from both directions at once.

The PFIC Trap: Why Spanish Investment Products Punish American Investors explains the mechanics. The Europe-specific version of this whole sequence is in Investing in Retirement From Europe in 7 Steps.

How to Choose an Adviser

If you decide to work with someone, four questions separate most of the field.

How are you paid, and by whom?
Do you act as a fiduciary at all times, and will you put that in writing?
Are you a CERTIFIED FINANCIAL PLANNER professional?
Are you fee-only, meaning you receive no commissions from third parties?

The answers you want are straightforward. An adviser who is uncomfortable answering any of them has told you something useful.

Frequently Asked Questions

How much do I need before I start investing?

Less than most people assume. The emergency fund in step 4 generally comes first, though. What matters more than the starting amount is that the money has a goal and a horizon attached to it.

What is the most common mistake new investors make?

They take more risk than they can hold through a decline. Then they sell at the bottom. That single behavior does more damage than almost any allocation error.

Does this change if I move abroad?

Steps 1 through 5 do not change. Steps 6 and 7 change substantially. Account access and product eligibility both depend on where you are resident.

Working With a Cross-Border Advisor

Cross Border Wealth Advisors is a fee-only fiduciary firm. We serve US citizens living in or moving to Spain. If your plan involves living outside the United States, settle the account and product questions above before you invest.

Everything above is general information, not advice about your situation. You can schedule an introductory conversation at cbwealthadvisors.com or email info@cbwealthadvisors.com.

Disclosures

This article is general educational information published by Cross Border Wealth Advisors, a company of Gersten Financial Planning Inc., an investment adviser registered with the State of California (CRD 309890). It is not investment, tax, legal or immigration advice.

Investing involves risk, including the possible loss of principal. Diversification does not guarantee a profit. Past performance is not indicative of future results.

Rules and figures change. The ones here are stated as of the date above. Cross Border Wealth Advisors is fee-only and receives no commissions. Registration does not imply a certain level of skill or training.

Please read the full article disclosures, which apply to everything published here.