In Step 4 we learnt about the different kinds of investments, their characteristics, and how these could help us create secondary income sources. In this step, we'll learn how to apply what we learnt and create investments to propel us towards the green zone.

Goals

We're still in the blue zone, which means that though our expenses are less than our income, we still have to keep working. Our goal in this step is to create investments that will in due course generate enough secondary income for us to get to the green zone.

Actions

Our actions in this step can be listed as:

• Understanding how investments work. We already did this in in Financial Independence - Step 4: Learning to Invest.
• Selecting investments.
• Starting to invest.
• Managing the investments.

Let's discuss the remaining steps in this article. The Investments Calculator is a good tool to try out what-if scenarios to identify the right mix of investments for us.

Starting to Invest

For those of us that have never invested before, putting our money where we don't get to see it every day is a bit daunting. We are worried that investment may suddenly lose value and we didn't know about it. That feeling is natural and totally understandable. The solution is to invest just a little bit and learn how investments work by watching our investment grow, until we're comfortable with the process. We could also try a few different investment types to compare and contrast their various characteristics and decide which ones make us feel better and which ones could make us lose sleep at night.

For example, here's what I started out with:

• I invested only 25% of my savings. The other 75% continued to be in my bank account.
• Even within the 25%, I invested half of the 25% (i.e., 12.5%) in a low-risk, low-return, capital-preserving investment (CD)
• The other 12.5% of the savings was invested in a stock fund (a total return fund).

Thus, this is how my money was allocated:

• Cash (checking account in bank) − risk level: very low: 75%
• CD − risk level: very low: 12.5%
• Stock fund − risk level: medium: 12.5%

This helped me learn about how CDs and stock funds work, risking only a small portion of my money. (In the meantime, I also read about other kinds of investments such government bonds such as treasury bills, corporate bond funds, etc., to also understand the risk vs. reward characteristics of these.) Later, as the returns from the investments grow, I increased my investment in them.

Your financial advisor who understands your specific financial situation is probably the best person to advice you on which mix of investments will work best for you in both the short term and long term.

Selecting Investments

When deciding to invest, the questions to ask ourselves are:

• How much do I have to invest?
• Can I add more money to the investments regularly (every pay period, every month, every year, etc.)?
• How risk averse am I? Do I shy from potentially lucrative investments due to my risk aversion?
• Conversely, how greedy am I? Will my greed cloud my judgment and make me invest in high-risk investments?

We understand the characteristics of different investments:

• Is the investment stable? Or, do the gains and losses fluctuate madly?
• Does the investment provide a high enough rate of return?
• Does the investment have any minimum amount criteria for either the principal or for periodic additions?
• Is it a short-, medium-, or long-term investment?
• What are the tax implications of the investment?

Once we understand the risk vs reward profiles of the investments, we're in a good position to match them against our own requirements and decide what's best for us. A good impartial financial advisor is a great asset here to help us create a portfolio of investments best suited for us.

Growing the Investments

Once we've been investing for a few months and are seeing our investments generate a little bit of gain, we can say that we've just stepped inside the green zone! Of course, we're still a long way from having our secondary income cover all our expenses. We need to manage our investments well so that they continue to grow. There are several aspects and techniques for this. We can enlist the help of a good financial advisor for most of these.

Managing the Investments

We (or our financial advisor, on our behalf) need to periodically check how our investments are doing. Good financial managers have several techniques to ensure that our investments are performing optimally.

Taxes

The gains generated by the investments could be taxable, depending on the type of investment. (The article Understanding Investment Types describes the basics of different investment types, including their tax characteristics.) We (with the help of our financial advisors) need to incorporate this knowledge into our annual tax preparation exercise.

Identifying New Investments

We started with modest investments that allowed us to get comfortable with investing. Once our gains grow, we can revisit the various investment types to identify additional lucrative (and safe) investments that are now relevant for us.

Other Tasks

Though we've started investing and are steadily moving towards the green zone, it is still a good idea to do a spot check on our expenses using the budget we created a while ago. This is to ensure that our expenses are in check and don't diminish our savings that we can periodically add to our investments. If we get complacent and lose control over our expenses, our diminished savings could cause our investments to grow much slower than what we want it to.

Our tasks could look like this:

• Each pay-period: Invest any savings, or accumulate them for later investment.
• Every month: Check budget envelope vs actual.
• Every quarter: Check how the investments are growing. If our plan was to add to our investments every quarter, now is the time to do it.
• Every year: Handle any tax-related action items. If our plan was to add to our investments annually, now is the time to do it.

Next Steps

On our way to full membership of the green zone, we can create milestones for ourselves to mark our progress:

• Extend the three month emergency reserve we created earlier to create a two year cushion so that we have a longer window to recover from losses.
• We can chunk our expenses into logical parts so that we can target 100% financial independence chunk by chunk. For example: instead of waiting for, say 5 years, for 100% financial independence for all our expenses, we can start with financial independence for all our travel expenses, then for our utilities expenses, and so on. This is similar to how we eliminate credit card debts one card at a time.

These are just some ideas on how short-term milestones can be causes for celebration and keep us encouraged on our path to full financial independence.

Summary

We learnt about the various investment types and techniques and selected a few that's best for us. We've successfully created an investment engine using our savings and are periodically funding it. We're seeing our motivation, discipline, and personal sacrifices paying off to get us to full financial independence.