You’ve looked at your income and your expenses and have determined that you have money left over. Should you invest it?
Before you entertain the idea of investing your money, you need to make sure the rest of your financial life is in order. Here’s how to do that.
Don’t even think about investing any money in the stock market or anywhere else until you do this.
Invest in yourself first – your “human capital”. If you need to improve your job skills by taking a course, set aside money to allow for that. You have complete control over investing in yourself, and you will never have that control over investing anywhere else. You can also make extra money apart from a regular job by developing a second or related set of skills.
Participate in your company’s 401(k) plan if you have that option Should You Participate in a 401(k) Plan?
Establish an emergency fund for yourself. Think about what your biggest exposure is and set aside money to cover it. For example – an unanticipated car repair bill or an unanticipated vet bill. Don’t be like the large minority of Americans who cannot meet an unexpected $400 expense without borrowing it from friends or charging it to a credit card knowing they cannot pay the bill in the next billing cycle.
Understand the difference between good debt and bad debt. Good debt is money owed on an asset that is likely to appreciate such as a house bought at a fair price. Bad debt is money owed on credit cards or money owed on assets that depreciate such as a car.
Pay off all credit card debt but do not be in a rush to pay off your student loans.
Pay off outstanding balances on car loans. That is “bad” debt, tied to an asset that depreciates in value. And depreciates significantly in the first 3 years.
Assuming you’ve met all of the above – congratulations for a great beginning. Now:
If you are highly risk averse – you don’t sleep well at night watching your investments rise and decline, you should think carefully about investing in stocks or any other vehicle that is subject to increases and decreases in value.
If you have difficulty separating emotions from objective financial decisions, you should acknowledge this and ask yourself how that might affect your future behavior making good investment choices.
Be able to explain in one sentence why you bought or are thinking of buying a particular stock, bond, mutual fund, etc., and be able to explain before you buy it what would have to happen for you to consider selling it.
Read everything, be skeptical of everything, and watch out for hidden agendas. It takes time and effort to learn how to eliminate the “noise” found on the television, in books and articles, and on the Internet.
Never act on a “hot tip”, regardless of the source.
Understand the difference between speculating and investing. If you don’t know the difference, you’re already in trouble. Go back to “Read everything”.
Take a look at Why You Need an Investment Policy Statement (IPS) For Investments. And then be able to define your investment objectives and your risk tolerance.
Start small and build on successes.
Consider whether you want or need professional help: How to Choose and Work With a Financial Adviser.