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| Manage two financial lives: one for personal income & expenses and one for investments. |
No matter much money you earn, once you begin investing you need to think of your investment portfolio as a separate financial world. It's not money you should borrow from. Nor is it money you can make up for out of your remaining income. Whether you only invest 2% of your paycheck, 10%, or some random spare change doesn't matter. Once that money leaves your personal budget you must treat it as though it is gone forever.
This was a tough lesson for me to learn. When I first began investing in the stock market I used a 401(k) plan. That was a mistake, I know, because when I lost my job I had to pay a 10% early withdrawal penalty. Why didn't I just roll the money over to an IRA? Because we needed to pay our bills. We had no savings.
When we got back on our feet we decided to do things differently. Now we save first and invest later. But once that money goes into the investment portfolio we brick wall it. In other words, we don't take it back. That's a hard decision to live by. The only way to make this choice work was to begin investing with small amounts.
Fortunately I found a job that offered an employee stock option plan. Every quarter we were awarded stock options. Most people used them to cash in and pick up some extra money. I decided I would use the money I made on the stock options to buy into an index fund. My options didn't net me much money but gradually we built up a portfolio.
We were able to do this because we didn't budget for that extra money. We're already saving from our two paychecks. We don't have much money left over after we pay the mortgage, two car loans, a college loan payment, and all our regular bills.
After a couple of years I began feeling a little more confident in our finances. My wife and I talked about what we can do with the extra money we get every quarter. We agreed to dump it into a money market account tied to our investing account. This way we've got a little bit of flexibility. We're not expecting to make any big changes in our investing strategy but twice a year we use the money market fund to increase our position in a couple of index funds. We wait to see which fund looks more promising.
You'd be right to say we could count on that money market fund for an emergency. The thought has crossed our mind but our cardinal rule of investing is the same: don't pull the money out of the portfolio. We have about $1600 in our savings account. You might not think that's much money but it keeps us afloat. There have been a few times where we had to pull money out of savings to handle an unexpected bill.
We have a second savings plan. We both have universal life policies. We invest a little money in those policies to build up their cash value. That way if we have to stop making premium payments for a while they can cover the costs until we catch up.
I don't know if we'll be able to save enough for retirement but we've learned our lesson on 401(k) plans. Deferred tax investing is only a good option when you have a strong savings balance to carry you through a tough situation. You cannot use your retirement plan for an emergency fund. That will suck all the growth out of your investments.
