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Wednesday, May 9, 2018

5 Ways to Know When You Should Start Investing

5 Ways to Know When You Should Start Investing

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5 Ways to Know When You’re Ready to Start Investing

Sya W. says, “In a couple of months I’ll be 19 and starting college. I work my tail off and still don’t bring home enough money. But even though I’m completely new to investing and know I’m not just going to 'get rich quick,' I want to create a good future for myself over the long term.

My main concern about investing in the stock market is being too young, because I’m bound to make mistakes. Do you think it’s too soon for me to invest or should I just go for it?”

Thanks for your question, Sya! I love that you’re thinking about your future at a young age and asking the right questions. Being curious and seeking knowledge is fundamental for achieving success, so I’m certain that there’s an amazing future ahead of you.

Starting early allows your money to compound and grow exponentially over time—even if you don’t have much to invest. So, my advice is to always start investing as early as possible. However, there are some key financial priorities and tasks that you should accomplish first.

In this post, I’ll cover five ways to know when you’re ready to invest. You’ll come away with a clear plan to prepare your finances and mindset, no matter how much or little money you have.

5 Ways to Know When You Should Start Investing

  1. You have emergency savings. 
  2. You have key insurance coverage. 
  3. You don’t have any dangerous debts. 
  4. You want money to grow over the long term. 
  5. You opened a retirement account.

Here’s more detail about each of the five ways to know when you’re ready to start investing.

See also: 7 Micro Habits That Create Financial Success

1. You have emergency savings.

Before you begin investing, your first financial priority should be accumulating some amount of emergency savings. Having a cash reserve is never a luxury, it’s a fundamental safety net that you should never go without.

Having a cash reserve is never a luxury, it’s a fundamental safety net that you should never go without.

Life is full of surprises and many of them drain your bank account! So before spending a dime on investments, ask yourself if you’re really prepared for the unexpected. In an instant, you could lose your job, see your business income dry up, get a serious illness, or experience a natural disaster. It’s not fun to think about these types of devastating situations, but they happen.

While no amount of money can reverse a tragedy, having a financial safety net can make it so much easier to cope. What you need depends on factors such as your living expenses, debt payments, income, and whether you have dependents.

At a minimum, strive to maintain an emergency fund equal to three to six months’ worth of your living expenses. For instance, if you spend $3,000 a month on essentials (such as housing, utilities, food, and debt payments), make a goal to keep at least three times that amount, or $9,000, in an FDIC-insured bank savings account.

You might set aside 5% or 10% of your gross pay or have $25 from each paycheck direct deposited into a savings account until you have a healthy cash cushion to land on if you’re faced with financial emergency.

If accumulating that much money seems out of reach, don’t worry. Just get started with a small goal, such as saving $500, then $1,000, until you have at least one month’s worth of security on hand.

Having even a small cash reserve is better than nothing because it can keep you from going into debt in the first place if you hit a rough financial patch (and who hasn’t?). Then continue building your emergency fund while you invest for the future at the same time.

A common question is whether you should invest your savings since the interest paid on a bank account is so low. The answer is almost always no, unless you have more than enough cash on hand.  

In general, your savings should not be invested because the value could drop at the exact moment you need to spend it. Remember that the purpose of an emergency fund is not to put it at risk to make it grow, but to preserve it so you can tap it in an instant if you need it.

See also: Should You Invest Emergency Funds or Keep Cash?


2. You have key insurance coverage.

Another key way to prepare for the unexpected and stay out of debt is to have the right kinds of insurance. Being underinsured or uninsured means that a disaster, theft, or accident could wipe out everything you’ve worked so hard to earn and jeopardize your entire financial future. 

Being underinsured or uninsured means that a disaster, theft, or accident could wipe out everything you’ve worked so hard to earn and jeopardize your entire financial future.

Before you begin investing, make sure you’ve considered purchasing five key types of insurance to protect your finances:

  • Auto insurance: This is required up to minimum state levels if you own a car. Even if you don’t, having a non-owner policy is wise if you regularly drive other peoples’ vehicles. But remember that having just the minimum oftentimes isn’t nearly enough. For instance, let’s say your state only requires you to purchase $10,000 of auto liability coverage. If you hurt someone and get sued for injuries and medical payments that total $200,000, you’d be on the hook for the balance of $190,000.  
  • Home insurance: This is required by lenders when you have a mortgage. It covers your dwelling, personal belongings, liability, and living expenses if you’re forced to move out after a disaster. Again, make sure you have more than the minimum amount of liability, if needed. The more income and assets you own, the more coverage you should have to stay safe. Also, if you’re a renter, don’t forget that you need coverage too. Renters insurance covers your personal belongings, liability, and living expenses if you’re forced to move out after a disaster. It’s a bargain for the protections your get, costing less than $200 per year on average.  
  • Health insurance: This is a non-negotiable coverage that every human being should have to protect both your health and your finances. All it takes is one visit to the emergency room or a short stay in a hospital to rack up a massive medical bill that could turn your financial world upside down.  
  • Disability insurance: This is an often-overlooked coverage that replaces a portion of your income (such as 60%) if you can’t work due to a covered illness, injury, or accident. These could include having cancer, a back injury, heart disease, or becoming pregnant. There’s a one in three chance that you’ll become disabled for at least three months sometime during your working years. But if you have a disability policy, you can continue to pay your bills even when you can’t earn an income.  
  • Life insurance: This is a must for anyone with a spouse, partner, or family who would be hurt financially if you died. You can protect loved ones with inexpensive term coverage that may not cost more than $200 a year for a $500,000 benefit, if you’re in relatively good health.

Check out Policygenius to get free quotes for any of these types of insurance. The key to getting the best deal is to shop and compare quotes from multiple insurers.

The bottom line is that if you don’t have an emergency fund and don’t have insurance that’s critical for your safety, you’re living on the edge. Shore up your financial defenses before you begin investing.

See also: 3 Facts About Usage-Based Car Insurance That Can Save Money 

3. You don’t have any dangerous debts.

In my book, Money Girl’s Smart Moves to Grow Rich, and my new online course, Get Out of Debt Fast—A Proven Plan to Stay Debt-Free Forever, I offer lots of detailed advice about managing debt. One important point I cover is that dealing with any dangerous debts—such as delinquent taxes, overdue child support, or a judgement from a collections agency—should be a priority.

If you have a large amount of dangerous debt, you may need to seek legal advice to make the best decisions about getting it under control before you start investing.

When serious debt looms over you, take care of it quickly so it doesn’t wreak havoc on your financial life. If you have a large amount of dangerous debt, you may need to seek legal advice to make the best decisions about getting it under control before you start investing.

I also recommend addressing high-rate debt, such as a credit card that’s in the double-digits. Consider what’s more profitable: saving the interest you’re currently paying or investing money with the expectation that it will grow.

Paying off debt gives you a straightforward, guaranteed return. For instance, if you’re carrying debt on a credit card that charges 26% interest annually, paying it off is an immediate 26% return.

You’d be hard-pressed to find an investment that pays a 26% return after taxes. So, paying off that high interest credit card is a much smarter financial move than investing. But it’s a tougher call when you have more reasonable debt, such as a 4% mortgage or a 5% student loan, that also come with tax deductions.

I’d argue that you can invest and get a return that exceeds the interest rate you’re paying for a mortgage or student loan. Plus, paying off a low-interest loan early could leave you cash-poor in the case of an emergency.

My advice is to invest your extra money, instead of using it to pay down debt, when the after-tax earnings should be higher than the after-tax interest rate you're paying. However, the best choice for you depends on your risk tolerance. It’s called personal finances because we’re all different. Decisions that make you feel comfortable may seem very risky to the next person.

If you still feel conflicted about the debt-versus-investing issue, one solution is to do both. You could send half your extra money to prepay a low-rate debt and half to an investment. But I want to be clear that paying down dangerous or high-rate debt should generally come before investing.


4. You want money to grow over the long term.

Once you’ve prepared for unexpected events that could be around the corner and addressed any dangerous debts, it’s time to turn your attention to investing. But first, let’s take a step back and remember why you need to invest in the first place.

Why do you really need to put any amount of your money at risk in the first place? The answer is that most people can’t achieve their long-term goals and build enough wealth without investing. If you leave money for retirement in a safe, but low-rate bank savings or CD, it doesn’t have the opportunity to grow.

In fact, leaving money in a savings accounts can cause you to lose money. That’s because the historical rate of inflation has been about 3%. So, if you earn less than 3%, your money loses value over the long term.

If you earn less than 3%, your money loses value over the long term.

To get over that hurdle, and hopefully earn double or triple that rate of return, you’ve got to invest. The reality is that not taking enough investment risk can be the riskiest move of all!

Historically, a diversified stock portfolio has earned an average of 10%. But even if you only get a 7% average return, you’ll have over $1 million to spend during retirement if you invest $400 a month for 40 years.

But higher return investments usually bring higher risks, so they need to be used carefully. In other words, investing means that you could possibly lose money. This risk creates a tension that keeps many people from getting started investing in the first place.

If you’re hesitant to begin, it’s time to jump in and make a goal to invest as much as possible as soon as possible. The ideal amount is a minimum of 10% to 15% of your income.

But if you can’t set aside that much, there’s no shame in starting small. Even investing 1% or $20 a month is a great start and is better than nothing. Then increase your contributions by a percent or two each year. And if you’re starting late, don’t stress about it—just get motivated to start right now.

To sum up, a savings account is the perfect place for your emergency fund. But when your goal is to build a big nest egg for the future, letting your money earn next to nothing in a low-interest savings account won’t get you there.

5. You have a retirement account.

The final way you know that you’re ready to invest for the long-term is when you’ve opened a retirement account. To get faster results, it’s wise to max out a tax-advantaged retirement account before you put money in a regular, taxable investing account.

To get faster results, it’s wise to max out a tax-advantaged retirement account before you put money in a regular, taxable investing account.

If you have a retirement plan at work, such as a 401k or 403b, that’s the first place your money should go. I’m a big fan of these plans because they give you multiple benefits. Not only do they automate investing by deducting contributions straight out of your paycheck before you can spend them, retirement plans cut your taxes. And you can take all your money with you (including any vested matching funds) if you leave the company.

Don’t have a job that offers a retirement plan? No problem, just about everyone can have an IRA (Individual Retirement Arrangement). And there are retirement accounts for the self-employed, such as a SEP IRA or Solo 401k.

Set it up for monthly recurring electronic contributions from your checking account so your investments are spread out over the year and happen on autopilot. Just remember that taking money out of a retirement account generally means getting hit with a 10% early withdrawal penalty if you’re younger than age 59½. So, it’s wise to leave retirement accounts untouched for as long as possible to avoid taxes and penalties and get maximum growth.

One of the most powerful ways to build wealth and financial security is pretty boring. Simply choose low-cost funds inside a retirement account and contribute 10% to 15% of your income over a long period of time.

So never forget to start investing as early as possible. It’s a huge mistake to believe that you don’t earn enough to invest now and will catch up later. If you wait for a someday raise, bonus, or windfall, you’re burning precious time.

Years from now when you’ve got savings and investments to fall back on or to fund the lifestyle of your dreams, you’ll be so happy that you took control of your financial future.

See also: 7 Simple Principles to Invest Wisely No Matter Your Age  

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May 9, 2018 at 03:51PM

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