Investing is a key factor in growing wealth efficiently, but investing is different than saving. You’re putting risk on your money. The hope is the risk pays off with a healthy return, but sometimes you lose money, or sometimes people panic and cash out when the market is taking a tumble. That’s why it’s important to be in a financially stable position before you get started.
Quick plea about why investing is important
Investing allows you to take advantage of compound interest. When coupled with time and consistency, that means smaller amounts can snowball. Purely trying to save your way to wealth is a much tougher feat.
For example, if you started investing $100 a month into a basic index fund that gave you a 7 percent return on average, in 30 years you’d have just over $114,000. Saving that same amount would yield a little over $36,000 – especially in a low-interest savings account. Little bits, when invested, add up quickly!
Now, imagine if instead of just $100, you started putting more than $100 into the stock market or your employer matched your contribution. Try playing around with the possibilities yourself.
6 tasks to accomplish before investing
1. Set goals
Goal setting is a critical part of investing. There needs to be a “why” behind your choices to invest, and that’s typically tied to what’s known as a time horizon.
Time horizon is just a fancy investing term for “when do you need access to the money you’re investing?” You can take more risk on money you won’t need for decades. Money you need in the next five to ten years will have a different asset allocation.
2. Have a budget
A budget simply means you’ve mastered your money! You are in control and know all the ins and outs of where your money goes each month. Without that knowledge, you aren’t ready to invest.
3. Eliminate high-interest debt
Credit cards are a good example of high-interest debt. Usually, you’re paying 15 percent on the low end and even close to 30 percent in interest on credit cards. You’re not likely to average returns like that in the stock market, so it doesn’t make sense for you to be investing over paying off that debt.
Student loans, however, can be a bit of a different situation. If your interest rate is under 5 percent, you can likely balance some investing if your risk tolerance allows.
4. A fully-funded emergency savings
Do not put risk on your money unless you’ve protected yourself against Murphy’s Law. Things will absolutely go wrong – whether that’s a job loss, a broken bone, or a blown tire on your car. You should not invest without a minimum of three months’ living expenses in a savings account. Do not invest your emergency fund.
5. You’ve started learning about the stock market
How to navigate the stock market shouldn’t be learned through trial and error. You should take the time to educate yourself about the stock market and how it works before you start investing. I’m not an advocate for individual stock picking either.
6. Retirement is your first adventure into investing
Because the language around retirement is usually “save for retirement” people often fail to think of themselves as investors. But when you’re contributing to a retirement fund, you’re doing just that. You are investing.
Speaking of retirement: the exception to the rule
Of course, there is always an exception to the rule! In this case, it’s saving for retirement. Which, by the way, I believe is a misnomer. You’re really investing for retirement. But we commonly say savings.
If you’re currently working a job at which you get an employer-matched retirement plan as a benefit, then yes, you should take advantage of getting the match. That’s true even if you’re paying off debt, don’t have your emergency savings completely funded, or haven’t set your financial goals. If you currently can’t afford to get the full match, try putting away just one percent to get some of the match on your retirement account.