Updated: Jan 9, 2019
Note: this is a guest post from Ed Canty, partners with Ryan Scribner, a financial YouTuber with over 300k subscribers.
Investing your money is one of the most important factors when trying to accumulate significant wealth. Without investing your money its value will eventually erode as inflation takes its toll over time.
Before we start investing it is important that we check off a few boxes on our financial plan. This will ensure that we are investing when the time is right for us, rather than jumping into an investment that we can't afford.
The first step, and most important, is we must make sure we have adequate resources for living, emergencies, food, rent, and any unexpected expenses.
I've had friends and clients who have lived uncomfortable lifestyles because they've invested all their money and didn’t leave much to live off of. While this can be a great way to save money, there is always a balance. You never want to sacrifice a comfortable lifestyle just so you can invest more money. If you are sweating to invest an extra $30, rather than going out with your friends that night you may want to make sure you are prioritizing yourself over your money. You shouldn't limit yourself, happiness is one of the most important factors when developing a financial plan. A balanced lifestyle with manageable spending habits is key. While people who live below their means and invest the difference tend to be the best wealth accumulators.
An emergency fund or safety net is extremely important for anyone supporting themselves. You will want to make sure you have enough money stashed for all your living expenses over the next few months as well as an extra cushion for the unexpected car repair or medical bill.
I’ve seen many unfortunate scenarios where a person goes through a major life event and they are not financially prepared. Life naturally takes unexpected turns and it may seem impossible to plan for such events. Suddenly losing your job or being hit with a huge repair bill can easily wipe out your savings. It is important to build up a cushion for these unexpected events. Otherwise, you could find yourself in a deep mess of financial instability.
It is suggested that you save enough money in an emergency fund for 3 to 6 months of all your nondiscretionary expenses. These are all your expenses that are absolutely vital and necessary for you to live off of. This includes your rent, food, transportation, etc. This amount will be different for everyone and completely depends on your lifestyle. For some people, $10,000 will work as an emergency fund. For others, they may need $50,000 as a safety net.
You will want to make sure your emergency fund is in a liquid account so you will have relatively quick access to your funds in an emergency. You may want to use a savings account or a liquid money market account. Try to get a reasonable interest rate on your emergency fund without tying your money up in something like a CD or long-term bond which you won't be able to access at a moments notice. The whole point of an emergency fund is to have resources when life takes an unexpected turn, it is important to make sure your emergency fund is accessible.
Once you have saved up enough in your emergency fund its time for step 2... paying off debt.
This is a topic people love to debate. We have all heard someone say "if I can invest my money and earn a higher return than the interest rate I'm paying on my loan, then why would I pay off my debt?" This can certainly be true sometimes...
Debt can fall into two categories, good debt, and bad debt. For example, mortgages allow people to live more comfortable lifestyles and afford an expensive asset by paying for it over time. If you have a long-term loan and a reasonable interest rate on your mortgage then it most likely is good debt (unless you bought a house you can't afford).
Where people struggle is with bad debt. This is the credit card debt and the personal loans that many times carry absurd interest rates along with it. These are the unaffordable home renovations and the frivolous and expensive large asset purchases.
Before we invest we must make sure we pay off all our bad debt. The average American has $1,500 in credit card debt. With many credit card APR's approaching 25% it makes no sense to invest your money without paying off your debt. By chipping away at your credit card balance you are instantly getting a 25% return. Paying off credit card debt is one of the only ways to get a guaranteed 25% return!
Student loans are another area you will want to focus on before you invest. It can be daunting, but once you can afford to do it, paying off any of your student loans should be a top priority. For most people entering the workforce, paying off student loans will be their priority in their first working years.
To sum it up, these are general rules that will apply to many people, but not all. Everyone has their own financial situation and their own ideas and goals for their money. Investing is extremely important, but knowing when to do so can be even more crucial.
Ed is a Financial Planner and registered investment advisor. Over on his blog, Investing Simple, he talks about investing and personal finance related topics.