The investment bug has bitten you. Perhaps you’ve been reading that it’s a “bear market” for stocks, and the time is right to buy beaten-down stocks at a “discount.” Or, maybe you’ve read or heard about the amazing opportunities available with cryptocurrency, and you’re experiencing a case of FOMO (fear of missing out).
Whatever your reasons or where your interest lies, investing a portion of your money is a smart move – when the time is right. Because you never know when any market is at the top or the bottom, timing the market itself is never a smart move. But making sure the time is right for you personally is a wise move.
Financial experts may not agree on the best investment, but most agree on one thing – you must have your financial house in order before investing. In other words, you must have adhered to some of the fundamentals of personal finance before you take the plunge into the world of investing.
To help you be prepared to the utmost, here are five steps to take before investing.
Step 1: Build up your emergency fund.
The foundation of any financial plan is to have an emergency fund to pay for unexpected expenses when events happen that are beyond your control. This includes things like a prolonged period of unemployment, your transmission needing to be repaired or replaced, or an onslaught of medical bills that need to be paid before your deductible is met.
Most advisors agree that you should have a minimum of 3 months of income in an emergency fund if you’re a working couple or six months if you’re single or the sole earner in the family. And remember, this is a “put and leave” account, not a “put and take.”
Step 2: Pay off your short-term debt.
Short-term debt is considered any debt that needs to be paid off within the next 12 months. This would include credit card debt, installment loans, and any personal loans you may have.
Over 50% of people who carry a balance on one or more credit cards say it creates stress in their life. The primary reason: they’re paying interest rates of 18% and higher on things they usually didn’t need in the first place.
It makes no sense to pay an 18% annual percentage rate on a credit card balance when you’re investing in a mutual fund that has returned an average of 12% over the past ten years. It makes better sense to eliminate the credit card and other high-interest rate debt before you invest.
Step 3: Participate in a retirement plan.
Some people get so excited about investing that they jump the gun and begin investing on their own before they invest in a retirement plan, like a 401(k) plan where they work or an Individual Retirement Account (IRA). Why is this a mistake? In a word – taxes.
Retirement plans such as 401(k)s and IRAs provide you with tax advantages that individual investing doesn’t. Depending on the type of retirement plan, the money you put into the plan might not be taxed before it goes into your retirement account, it might be tax-deductible, or it might not be taxed when you take the money out of your plan.
On the contrary, investments you make outside of a retirement plan are typically made with after-tax money, not deductible, and you’re taxed on your profits. This doesn’t make investing a bad choice; it just means it should be done after you’ve maxed out your retirement plan contributions.
Step 4: Make sure you’re adequately insured.
Remember that you’re the goose that lays the golden eggs for your investments. If something happens to you, your health, or your income, you won’t be able to keep investing, and you might need to liquidate what you’ve already invested to meet your obligations.
For that reason, be sure you have the right type and amounts of insurance in place to protect your health, income, and life:
1. Health insurance:
consider a high-deductible health insurance plan if you rarely see your doctor and are in good health. The money you save in monthly premiums over a PPO or low-deductible plan can be invested, and your emergency fund can help pay your out-of-pocket medical expenses.
2. Disability insurance:
many people neglect to have long-term disability insurance protection. If you get sick or injured and don’t have this coverage, your employer will probably not continue paying you until you get back to work. And, they’re probably not going to pay your bills for you, either. Disability insurance will.
3. Life insurance:
if you have anyone dependent on your income (spouse, partner, children, elderly parents), have at least an inexpensive term life insurance policy in place. Because of their high expenses and fees, expensive whole life and universal life insurance policies are no substitute for investing.
Step #5: Make and live off of a monthly budget.
Steps 1-4 are not going to be effective unless you have a budget you make and keep. Without knowing what you’re spending your money on, you won’t have enough left over each month for building up your emergency fund, paying off debt, contributing to your retirement, and paying for the necessary insurance.
With a budget, you’ll have the discretionary funds available to scratch your investing itch and be able to invest consistently, which is the hallmark of successful investors.
Final Thought
While it’s true that financially successful people invest before they spend, be sure you spend your time and money on these five steps before you call your broker or hop on your investing app. It’s better to have a solid financial foundation that your investments will build upon before putting your money to work in the market.
