6 Things You Need to Do Before You Start Investing
Are you thinking about investing money? People are often eager to invest when they hear some so-called investment gurus talking about a stock market boom or an increase in the gold price. Often, people risk losing money believing market rumors, and I have been on that bandwagon; it is not pretty.
Investment needs knowledge, discipline, and appetite for taking risks. No matter how eager and confident you are, do not jump right in unless you check all the boxes to safeguard yourself, your family, and your wealth.
Here are six steps you must take before you even consider investing.
Focus on Net-Worth
This is the most obvious sign that you are financially stable, but not everyone is focused on their net worth. The general thought is that if you have money in your bank account, you are well to do. What we forget are our debts.
For example, if I have $20,000 in my bank account, $5000 in my mutual fund, a personal loan of $15,000, and a credit card outstanding of $6,000. My net worth will be $4,000 ($25,000-$21,000).
Your net worth determines your risk-taking capability and your financial security if something goes wrong. From a long-term perspective, your goal should be to increase your net worth. That brings us to the primary step towards financial stability.
Be Frugal & Start a Budget
When I look at my finances at the end of a month, I see income, expenses, and the leftover that is left can be used to invest. The leftover is a small amount compared to my expenses and my income. The only way I can increase that leftover is by earning more or cutting unwanted costs. The increase in the leftover amount will help me invest more and get higher returns in the long term.
Earning more is not in our control and does not necessarily guarantee higher saving; with more disposable income; we tend to spend more. However, if we control our expenses, we have a good shot to see an immediate benefit that is in our control.
The thought of cutting costs is excruciating. You will need a lot of willpower to control this feeling. The best way to start cutting costs is to remove expenses you do not care about. Like a latte from Starbucks or an extra pack of chips from the supermarket. Things that you may not think of the very next moment or day. You do not need to let go of a fancy meal with friends or family or not buy a new phone.
The goal is simple, be frugal but not at the cost of your personal and social existence. Start small, and you will slowly understand the power of saving, and eventually, your leftover amount will grow exponentially.
Creating and maintaining a budget is like a new year’s resolution. Everyone knows they should do it, but no one follows through. Investment needs discipline, and the first step to great a healthy financial discipline is to create a budget. It will help you cut costs, maintain a good lifestyle while saving you a bucket full of money to invest.
When I started creating a budget not long ago, it surprised me that I spend so much money on things I do not need, or can do without. It was an eye-opener. For example, I bought a remote control car, played with it for a day, and now it is collecting dust at a corner of my house.
To make things simpler, you may choose to follow a 50/30/20 rule.
- 50% of your income must be used towards your essential needs like rent, food, fuel, mortgage, etc.
- 30% must be saved in instruments like retirement funds, mutual funds, etc.
- 20% can be used to meet your wants, like going out for a movie, traveling, purchasing a new phone, etc.
Get debt-free
If you have high-interest debt, like a personal loan, credit card, or any debt with an interest rate of over 8%, you must be doing nothing better than paying down the debt. It doesn’t make much sense to invest if your investment profits are lesser than the interests you pay on your debts.
Think of it in this way- If you make an extra payment for your loan or credit card debt, the bank will not charge interest on the extra amount. For example, if you pay $100 extra on your credit card, you will not be charged a 25% interest on that amount, that my friend, is 25% saving that could've been an expense. No investment instrument has such high returns in the short term.
Not only will you pay off your debts sooner than expected, but you will also increase your net worth and become financially stable.
Get medical insurance
People generally do not take medical insurance, thinking that they are healthy, and paying a premium for health insurance is not worth the investment. However, a medical emergency or an accident comes at the worst possible time and without any prior intimation. Paying a small premium every month will help you avoid financial distress and loss of savings during the time of need.
Especially if you are in a country with a weak health system, medical insurance is your best choice to pay exceptionally high private medical treatment costs. Before you start investing, make sure to take health insurance first.
Emergency funds
Like it or not, life is unpredictable. You might have a great investment plan, but what happens if you lose your job? What if your car breaks down? Many people turn to credit cards or personal loans in those situations, but credit cards aren’t the best solution. With an exceptionally high rate of interest, you will be left with another debt to manage. An emergency fund will help you and your family sustain in these difficult times without relying on debts.
As a principle, create a fund equivalent to your six-month salary before start investing. The internet era has enabled us to open an online savings account in a matter of minutes. Utilize these facilities to stash away your emergency funds.
Set a goal for your investment
Never invest without a goal. I have invested without goals in the past, and it took me a fraction of a second to dilute those investments the moment there was an emergency, or I needed something in exchange for that money.
Without a goal, there is no motivation to continue an investment as we are not aware of the reward at the end of the investment term. These goals can be as simple as buying a new car or a house or increase your net worth to a million dollars.
Creating a goal for your investment also enables you to think about the instruments you may want to use and your risk appetite. For example, the stock market is a very volatile investment instrument; in the short-term, you may lose all your investment; however, in the long term, decades in some instances, you may get an average of 8% return on your investment. If you are looking to invest to buy a car in 5 years, the stock market might not be the best investment strategy.
Before you invest, think about why are you investing? What will you do with the returns? How long will you need to invest to achieve your goal?
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Consult a financial professional before making any significant financial decisions.
