Hi! If you have ever thought of investing in the stock market as a way to reach FI (financial independence) then read on! By following these four simple steps, over time you can make enough money, completely passively by investing in stock to generate enough income to reach financial independence and never have to work again! This, by the way is the basic tenant of the FIRE movement (with the investment vehicle usually being ETF stocks) and advice given on investing by the world famous investor Warren Buffet.
1. Boost your income
I did this by developing a few side hustles, negotiating a long overdue pay-rise and by picking up some extra shifts. Check out my guide on how to make more money if you’re struggling for ideas to boost your income. Smart investors know you need to raise capital to start investing.
2. Live well below your means
Develop a budget and stick to it! Use your savings to first create an emergency fund of a few thousand dollars, and then focus on paying down any bad debt. I had some salary advances which I was paying off incrementally which was a dumb idea (due to the interest rate). I was able to pay this off outright however if I couldn’t do this I would consider a debt consolidation (which I learned about from reading the barefoot investor) where your loan gets sold off to a new creditor and you negotiate a lower interest rate (like a credit card balance transfer), and then pay it off. Now that I had free’d up some of my cash flow I was then able to build up investment capital. Check out our free guide on how to budget and save money.
3. Invest your capital in low cost ETF stock index funds
Create an online brokerage account and use it to buy good quality stock index funds such as ETFs and LICs. You can do this on the stock market in your name, in the name of your trust, company, or lower earning spouse name if you are concerned about tax. Make sure you consider fee’s and pick an ETF with ultra low management fees. There are also many different ETF (and LIC) index funds you can invest in. Check out my guide on index funds; LICs and ETFs to get the basics and work out which particular LIC or ETF index might be right for you, based on what I picked. I also describe my investment strategies here, which is important if you want to be a smart investor.
Whilst some people fancy themselves as stock pickers and believe they are smart investors, the fact of the matter is that only an extremely small number of people are able to consistently out perform the market by picking stocks and actively trading. The most famous of these statistical anomalies is the Oracle of Omaha, Mr Warren Buffet himself. And what is his advise? Buy a low cost index fund and hold it! The majority of investors are NOT smart investors, they are DUMB investors. And if you won’t take the advice of Warren Buffet, unfortunately not much will help you succeed in investing in the stock market.
Most investors fear a market downturn right after they make their investments, which is especially played on by the media. Remember that the majority of returns actually come from the dividends the stock produces, not the capital growth in the share price itself. Most companies continue to pay dividends like clockwork into your brokerage account regardless of the stock price, which is passed right on to you the smart investor, through your ETF stock index fund.
Crunch the numbers yourself, and you will see having significant idle capital is a defensive play like cash doesn’t pay off in the long run. It’s best to put this money to work as soon as possible, and continue to top up your investments as much as you can. It’s a great idea to keep a decent cash buffer, and this reserve means if the share price does go down that you can buy a heap more stock at a discount.
4. Manage your portfolio.
A very effective passive income investment strategy is to simply buy and hold the index, through index funds such as ETFs and LICs. Why would you want to kill the goose that lays golden eggs? Selling your ETF index funds means you’re up for a second round of brokerage fees, as well as potentially capital gains tax for any growth there has been in the share price.
By establishing a regular investment plan and buying more stock on a regular basis, you can even out the fluctuations in the stock price – over time, you statistically will have bought more stock when the stock market price is lower than you do when it’s higher, so your average price is reduced. This is called dollar-cost-averaging and is very popular in the FI (Financial Independence) community. Remember long term wealth is about time in the stock market, not timing the stock market – so continue to buy stock index and hold it for the long term.
You can also use your registrar to set up a Dividend share Substitution Plan DSSP, or Dividend Reinvestment Plan DRP, where you receive extra shares in your fund rather than having that juicy dividend hit your brokerage account. There are advantages to both policies, and you usually receive the additional shares at a discounted rate to the market price and with no brokerage fees. You need to do your own research and get specialist advice as to which is best suited to you. By reinvesting the dividends your shares produce, you can grow your portfolio even faster and then just sit back and watch your portfolio grow.
You will want a way of tracking your portfolio, So check out this guide on portfolio management.
Get rich slowly
Over time, the effect of compounding returns and dividends will grow your wealth. Whilst the share price may (and usually will) grow, the dividends produced is what you really care about. Reinvested, this lets your portfolio grow and eventually will become a valuable source of passive income, eventually providing more than enough for you to live on.
If you are able to save $1000 a month when you first enter the workforce at 18 years old, and invest this into good quality low cost index funds, assuming the market continues to perform on average (as it has over the past 200 years), by age 42 you would have made yourself over a cool one million dollars.
So – fancy being able to retire at 42 , having only ever invested $250 a week? This is the equivalent cost of a few luxury items such as a new car on finance or brand name clothing. For most of the work force, $250 doesn’t even represent a full days wage. A million dollars at a safe withdrawal rate of 4% means you can live off a passive income of $40,000 for the rest of your life!
If you are able to invest more (by boosting your income or living more frugally) and invest $2000 a month, you can shave almost seven years off the process, and achieve this at age 35. Want to invest more? $3000 a month will get you your million by 32, and $5000 a month gets you your million within 10 years. Whilst more aggressive investment brings your wealth quicker, the reduced time period means compound interest has less time to work its magic and it is doing less of your heavy lifting for you (in the last case, compound returns makes up just over a third of the total portfolio). The same principle works with this investing strategy as it does paying off a home loan – check out a home loan calculator or mortgage calculator and play around with additional contributions and see the years shave off your mortgage!
So there you have it – a pretty straightforward guide to how to get rich slowly using the stock market!