Building Your Financial Foundation for Success: A Primer for New and Young Investors

In recent years, more and more of my clients have asked me to help their young adult children start an investment plan.

I often respond that I can either “give them a fish or teach them how to fish.”

In other words, I could simply open a brokerage account for them, like giving them a fish, or I could start by teaching them the fundamentals of investing.  

Most of the parents I work with appreciate this and like the idea of giving the next generation the knowledge and tools they’ll need to navigate the investing world.

When I speak to young investors, I like to use a housebuilding analogy: You don’t start building a house with the floor coverings and light fixtures. Instead, you begin with the foundation.

This is the same with investing. Before you start building an investment portfolio, it’s important to have a strong financial foundation.

Setting a foundation for success: 3 key questions to ask yourself 

I encourage new and young investors to consider three questions before they start investing.

1. Do you have outside savings that are liquid for your short-term needs?

For instance, do you have enough in your emergency fund to cover unexpected expenses? The general rule of thumb is to have enough to cover at least three to six months of your expenses.

Next, take a look at your financial goals. Are you saving to purchase a car, a home or some other large investment? Are you also looking to invest for these short-term goals?

If so, when putting together an investment plan, you’ll need access to investments that are relatively liquid and not hindered by potential tax penalties.

Depending on your personal goals, you may also need to consider taking out a loan, which leads to my next question.

2. Do you have current debts and are you managing them properly?

Debt can often sound like a bad word, but every now and then we may need to borrow money to help finance our goals, such as buying a car or a home. Still, it’s important to be judicious about how we take on and manage our debts.

Are you making credit cards work for you by paying them off on time each month? Or are you piling up high-interest debt that can easily get out of control? And how about other loans or financing?

Before you start investing, it’s a good idea to make sure your debt is under control.

3. If you’re employed, are you taking advantage of your employer-sponsored retirement plan?

Many companies offer 401(k) plans with different investment options to help you save for retirement. Employer-sponsored retirement plans can be a good way to help you build the discipline to save regularly.

To young investors, I always like to ask: Are you contributing enough to take advantage of any employer-matching program (if this is an option)?

For people who’ve never invested before or don’t know much about investing, these workplace plans can provide a good introduction to the world of investing.

Understanding the basics of investing

After going through these three questions, you can begin to think about opening a basic brokerage account, which is a tool that helps you invest in different assets (stocks, bonds, ETFs, etc.).

Many brokerage accounts offer a variety of broadly diversified funds at low cost. Some have low investment minimums and automatic investment features that can help make investing easy and systematic.

For those who aren’t familiar with investing, I also like to give a basic overview of important investing concepts.

For instance, I’ll usually go over the difference between ownership investments (e.g., stocks) and loanership investments (e.g., bonds) — and how every security has some element of ownership, loanership or both.

I believe combining ownership assets with loanership assets is the basis of building a diversified portfolio.

In addition to talking about how stocks, bonds, ETFs and mutual funds work (assets that I consider the brick and mortar of a basic portfolio for your foundation), I also try to cover the following:

• Dollar-cost averaging
• Diversification
• Risk tolerance
• Asset allocation
• Rebalancing 

I believe these concepts are fundamental aspects of investing, and understanding their importance is a key to building your financial literacy.

Making an investment portfolio your own

Once you have your financial foundation in place and start to invest, you can begin thinking about how to make your investment portfolio your own – one that is uniquely suited to your needs and goals.

In terms of the housebuilding analogy I mentioned earlier, this would be the stage of picking out furnishings and wall decorations for your home. Because each person’s financial situation is different, no two investment plans or portfolios are going to be the same.

Some may choose to tailor their portfolio by adding specific individual securities. These might be stocks in companies that you work for or have some other personal interest in – perhaps, something you’ve come across during your investment research.

Final thoughts

It’s never too early to talk to your children about the importance of building a solid financial foundation and help show them the way. And this isn’t something you have to do on your own. Consider bringing them in with you the next time you sit down with your financial advisor.

When clients ask me to help their children start an investment program, I see it as a timely opportunity to teach them the fundamentals because I believe financial literacy is essential for success.