Beginning Investing #1: Before You Start

So you’ve decided to begin investing.  Outstanding.  Way to go!  

This will be the first in a series of blogs to help get you started. 

But before you invest anything at all, there are two pre-investing steps I strongly encourage you to take. Unless you do these things, it will be hard to stay on the investment path.

Emergency Fund

First, you need to establish an emergency fund. This is money you set aside for small emergencies. The tires on the car must be replaced. The washing machine stops working. The springs start poking out of your mattress. The hard drive on your computer crashes.

Investing is a long term process of putting money away for a future goal. But before you can truly commit yourself toward a process of diligent monthly investment, you need a way to cover those emergency needs that will come about. If you don’t take this step, you’ll find yourself postponing your monthly investments because of the small emergency expenses that always seem to crop up.

How much should you set aside?  $1,000 is a good amount.  It will cover most small emergency needs.  But you must quickly replenish the fund anytime you dip into it.

How do you accumulate this $1,000?  Have a garage sale.  Stop eating at restaurants; instead, take lunches to work. Find a part-time, second job.  Forgo the Starbucks frappuccinos for a while.  Give up cable TV; watch shows on your computer.  Sell the spare Xbox console you don’t use.  Adjust the thermostat to save energy. Basically, do whatever you can to quickly establish your emergency fund. 

Credit Cards

Second, understand that the best “investment” you can make is to eliminate credit card debt. Let’s say you owe $1,000 to the credit card company, and are paying them 20% interest. Over the course of a year you would pay $200 in interest on that debt.

 If you have $1,000 to invest, and use it to pay off the credit card debt, then you save $200 over the next 12 months by not having to pay interest. Compare that to investing $1000 in stocks with a 10% return (which is the average for stocks), where you would make a $100 return over the next 12 months. Avoiding $200 in interest payments is a better use of your $1,000 than achieving a $100 return on your investments. Avoiding a $200 expense is better than generating $100 of investment income.

So, paying off credit cards offers a higher return. But also, paying off credit cards offers you a certain return.  Investments have risk; you might earn 10% on your stocks, but you might instead lose money.

Before you begin investing, pay off your credit card debt.  And once you’ve done that, only use credit cards if you’ll pay off the full balance every month. Otherwise you’re back to borrowing money at very high interest rates.

The same applies to any high-interest debt that you have – college loans, vacation loans, etc. Before you begin investing, you are better off to pay off any debt with an interest rate above 10%.