Investing in Your Ambition

Whether you already made the big leap to ditch your day job or you’re planning ahead to be your own boss, starting your own business is a big decision. Self-employment takes guts, and you wouldn’t even be thinking about it if you weren’t ambitious and full of gumption.

Whether you’re a freelancer, consultant or small business owner, you have unique circumstances that many others are unable to relate to, especially when it comes to money. As you may have already experienced, the freedom and autonomy that comes with being your own boss also comes with additional responsibilities and scarce resources. When it comes time to put your hard earned money to work for you, know that there are simple ways you can invest that will make you feel like a savvy CFO.

Is Investing Right For You?

The first question you should be asking yourself about investing in your ambition is whether investing in the market is the next logical step in your financial journey. You may be getting plenty of advice (both solicited and unsolicited) about how investing is a great idea and important for your financial well being, but it’s vitally important that we don’t skip any steps in building a strong financial foundation.

Before opening an investment account and transferring cash, assess whether you’ve accomplished a few other important steps first:

If their situation sounds familiar, rest assured in this video you will learn about a simple framework that focuses on the eight essential steps you can take on your journey to financial independence. As we go through this framework, it is important to note that the order matters.

  1. Have you stopped living on the edge? Living paycheck-to-paycheck (or contract-to-contract) is a reality for a lot of people. But there are small moves you can make—like tracking your budget and only spending cash you have—that can end up making a big difference to your financial situation. Everyone should have at least one month worth of expenses in cash to serve as a safety net between an unexpected event and a financial crisis.

  2. Have you protected your income? This is the time to make sure your income is protected through insurance planning such as disability and life insurance.

  3. Have you attacked bad debt? First of all, don’t panic. If you have high-interest rate debt, like credit card balances, you’re not alone—and there are ways out. Not all debt is created equal and you may want to focus your effort on tackling bad debt. Bad debt is any debt that has an interest rate greater than 7%.

  4. Do you have an emergency fund? Like bad traffic and bad dates, emergencies happen. While it’s impossible to predict when and how things will go wrong, you can do your best to financially prepare. Everyone should have three to six months worth of expenses in their emergency fund, but if you’re already self-employed you may feel like a higher amount is more appropriate. This is money that you do not want to take risk with, so is better suited for a savings account than investments. The great news though? Once you’ve accomplished these 4 things, you can start to think about investing!

Understanding Risk

Risk is more than just a board game. Though to be honest, I think the Risk game is probably one of the scariest risks that exist — have you ever played that game? It takes FOREVER.

Risk can be defined a few different ways, but in the world of investing we think of risk as the uncertainty that our realized return will not be the same as our expected return. There are many different types of risk, some that are applicable to all of your finances and some that are unique based on a specific type of asset. Some risks can be mitigated and some cannot.

Different types of investments come with different levels of risk and it’s reasonable to expect that as the level of risk increases so does the potential reward. So the more risk you are willing to take, the more you could gain but it’s also true that you could lose more, too. This fundamental relationship between risk and reward is one of the most important concepts to keep in mind as you begin to think about what types of investments are appropriate for a particular investor or goal.

An investor’s level of comfort taking risk is often referred to as their risk appetite. How much risk that investor can take on a particular investment based on their goal and time horizon is known as the risk tolerance. How much risk is appropriate or suitable for you to take will be dependent on a combination of these two components – your risk appetite and risk tolerance. Your risk appetite is tied to you, the individual investor, and your risk tolerance is tied to your individual investments.

A real life way to think about this is to compare how you might invest for retirement vs a home purchase. If you are planning to retire in 30 years but you’re hoping to purchase a new home in five, how you would invest for each of those goals would be different. Your appetite for risk remains the same, but how tolerant you would be about fluctuations in the outcome would be different.

Shorter term goals are less tolerant to risk. Let’s say you invest $100 for retirement in 30 years, and $100 towards a home purchase in 5 years. If the market goes down after you invest and your $100 is only worth $85 dollars, the money for retirement will continue to be invested long enough to rebound from the dip in value. The money for the home purchase however is needed sooner and may not be invested long enough to recuperate the loss. Therefore your tolerance for loss on short term investments is much lower, and guidance will be to take less risk in the short term and gradually add risk as your time horizon increases.

Aligning Your Investment Approach & Your Goals

If by now you’ve established that you’re ready to invest and you understand how to take risk, logistically the next step is to figure out what style of investing you prefer. Before opening an account, you’ll want to think about how involved you hope to be in the day-to-day decision making behind your investments.

Whether you’re using an IRA to build up your retirement, or a taxable account to grow your shorter-term investments, you’ll want to consider whether you prefer an active or passive approach to investing. (hint: you may actually like both, and that’s okay.)

Maybe you’re interested in learning more about the stock market. Perhaps you’re the kind of person who is willing to take a chance if it means a shot at beating the odds. Or maybe you trust yourself or a professional to have the smarts to predict which stocks are likely to do well. If any of these are the case, you may be interested in giving active investing a try.

Active investing can sound scary, but it doesn’t have to be intimidating. The active investment strategy definition is pretty straightforward: The term refers to trading individual stocks or bonds in an attempt to beat the ‘market’. You could be the one making these choices, or you could invest in mutual funds where managers actively make those decisions. If you’re saving for goals that are years away, such as retirement, or just prefer less risk and lower fees, you may want to think twice before adopting an active approach.

Active investing typically involves in-depth research into each stock purchase, as well as regularly watching the market in order to time buys and sells. Passive investing strategies either aim to bring in passive income or to grow a portfolio over time without as much day-to-day involvement. Passive investing is a strategy which looks to match the returns of the overall market, and often takes a buy and hold strategy once investments are chosen. This could be by buying a variety of individual securities and holding them for the long run, or simply investing in passive, low-cost funds like index funds.

One of these may sound more appealing to you than another, or maybe you can’t decide just yet and want to try both approaches to see which feels more comfortable — whatever your preferred style, SoFi can help.