Make no mistake: laying the framework for investing is something that anyone can do with a little time and effort. It only takes a little time, a little study, and a little self-evaluation to get there.
Before you invest in anything other than your savings account or retirement plan, there are ten things you should do first.
- Your net worth must become the most important number in your personal finances.
First and foremost, what is “net worth”?
The total value of everything you own – your house, car, any valuables that could be easily resold, and the balances of your checking account, savings account, and any investments you have – minus the total value of any and all debts you have – mortgage, credit cards, student loans, and so on – is your net worth.
So, if I had a $100,000 property and a $10,000 automobile, but owed $50,000 in student loans (and had no other debts), my net worth would be $60,000.
Your financial focus should be on this amount and how you can increase it more than anything else.
There are several methods to increase it, including paying down debts, not wasting money on frivolous or unnecessary purchases, increasing your income, and, yes, investing.
This may appear to be a no-brainer, but it isn’t.
My primary focus in my financial life used to be on my bank account balance.
Was I going to be able to make ends meet for the month?
What was the amount of money I had left over to spend on whatever came to mind?
To summarize the shift, focusing on your checking account is a very short-term approach, but focusing on your net worth is a distinctly long-term approach.
You shouldn’t invest if you don’t have a long-term perspective on things, and you don’t have a long-term view if your checking account balance is more significant and compelling than your net worth.
- You must pay off all of your high-interest debts, including credit cards.
If you have high-interest loans, such as those with an interest rate of more than 8%, there is nothing better you can do with your money than to pay them off.
There is no investment that comes close to matching the amount you’ll save by paying off your credit cards over the long term.
Consider this: making an extra payment on a credit card with a 15% interest rate is essentially the same as making an investment that returns 15% after taxes each year.
If you pay off $100 of that balance, you’ll save $15 in interest rates each year until you’ve paid off the card.
There is no other investment that can come close to that in terms of consistency.
Not only that, but paying off your credit card will have an immediate positive influence on your net worth, causing it to begin slowly increasing because it will no longer be hampered by interest and finance costs.
Not only that, but paying off your debts means having less monthly costs, which means you’ll have more money to invest right away.
It’s simple: If you have high-interest loans, paying them off should come first, far ahead of any considerations about investing.
Not only will they provide you with a higher return than any other investment, but paying them off will also increase your net worth and monthly cash flow.
This is the first step in the process.
Take command of the situation.
- You must get rid of the majority of your bad personal spending habits.
When I look at my money each month, I see them as a pile of revenue with expenses deducting from it.
The pile that remains is substantially smaller.
The disparity between my income and my spending is what I refer to as “the gap.”
That “gap” is money I can put into investments.
Naturally, I want that “gap” to widen so that I have more money to invest, allowing me to achieve my goals faster than before!
When it comes down to it, there are only two ways to increase your “gap” efficiently.
You have the option of spending less money or earning more money.
I could go on and on about ways to make more money – getting a better job, getting a raise, starting a business – but I’m going to concentrate on the spending side of the equation since it’s something you can do right now and see effects practically instantly.
When most people consider lowering their expenditure, they get a foul taste in their mouth right away.
They shouldn’t, either.
People have a negative reaction because they immediately think of the spending that they care about the most and don’t want to cut.
They recall spending money on rather opulent meals with good pals.
They recall the most recent hobby item they purchased and appreciated.
Cutting those objects seems like a poor idea.
And it’s a disaster.
Those aren’t the areas where you should make cuts.
What you should cut are the items that are easily forgotten, purchases that you won’t recall in a day, and items that are discreetly obtained and immediately forgotten.
A quick stop at the convenience store for a drink.
At the grocery shop, an extra item was thrown into the cart.
The digital object that was purchased on the spur of the moment, enjoyed once, and then forgotten about.
In the morning, a cappuccino drank without thought or actual enjoyment.
Those are the things you should cut, the things you won’t remember a day after spending.
Keep an eye out for those things.
Be on the lookout for them.
Stop yourself when you feel yourself about to spend money on something that doesn’t truly matter.
Don’t waste your money.
Take the purchasing out of your life.
Concentrate on breaking whatever habit got you to the point of making that rash purchase.
- You must create a cash emergency fund.
Whether we like it or not, life has a way of interfering with our best set plans.
You may have a solid investment strategy in place, but what if you lose your job?
What if you become ill?
What happens if your vehicle breaks down?
Many people turn to credit cards in these situations, but credit cards aren’t always the greatest option.
They provide no assistance with identity theft issues.
If you’re having financial difficulties, banks may cancel your cards.
Not only that, even if all goes smoothly, you’ll be saddled with a new debt, which could derail your ambitions.
That’s why I always recommend that everybody who invests have a strong cash emergency fund stashed away in a savings account.
Its main purpose is to ensure that life’s unexpected events do not derail your larger financial ambitions.
I’m a proponent of having a “perpetual” emergency fund.
Set up an online savings account with your preferred online bank (I recommend Ally and Capital One 360), and then set up an automated weekly transfer from your primary checking account into that account for a small amount that won’t break your budget but will add up quickly.
Then put it out of your mind.
Allow the money to accumulate over time.
Then, anytime you need money for an emergency (a job loss, for example), transfer it back into your checking account.
I propose that you never stop the transfer; if the amount becomes too large for your liking, take some money out of the account and invest it.
That’s the technique I employ, and it works flawlessly.
If you do this for the rest of your life, you’ll discover that you spend a lot less money on trivial things, which means you’ll have a lot more money to invest.
- You must determine your major life objectives.
One of the most important investing concepts is to never invest without a goal in mind.
There are several reasons for this, but the most important is that without a precise goal in mind, you won’t be able to determine your timetable for investing and how much risk you’re ready to take on, both of which are important considerations when investing.
Take, for example, the stock market.
It’s extremely volatile, which means that investing in the stock market carries a high level of short-term risk.
The stock market, on the other hand, tends to trend toward a reasonably constant 7% average annual return over the long haul – decades, in other words.
For stability, you simply have to be in it for the long haul.
As a result, investing in the stock market makes little sense if you have a short-term goal.
However, if you’re looking to invest for the long run, it can be a terrific option.
All of this consideration should begin with your own personal objectives.
Why are you making this investment?
What do you intend to do with the funds?
Do you want to be financially self-sufficient and live off the profits?
Because this is a long-term aim, stock investing may be appropriate.
On the other side, perhaps you’re planning to buy or construct a home in the next few years.
In that situation, stock investing is usually not the greatest option because you’ll need the money soon.
What are your objectives?
What is your motivation for doing this?
Before you spend any money, make sure you know what you’re getting into.
- You’ll Need Your Spouse’s Support for Your Plans
If you’re married, whatever investing strategy you pursue should be thoroughly addressed with your partner.
That conversation should include at least three crucial topics.
First and foremost, what is the goal?
What is the purpose of this investment strategy?
What do we hope to accomplish?
Second, what is your strategy?
How are we going to spend our money in order to reach this goal?
Do you think your financial selections are sound?
What accounts are there, and who is on them?
Is this something we both agree on, at the end of the day?
Is the aim something we both care about?
Is the plan in line with our beliefs while also accomplishing the goal?
If you don’t have this conversation with your spouse before you start investing, you’re setting yourself up for difficulty down the future, which might begin as soon as your spouse observes money disappearing into an investment account.
- You must have a solid grasp of your investment options.
Another crucial step before investing is to understand the various investment possibilities available to you and how to interpret them.
Do you understand the fundamentals of stocks, bonds, mutual funds, ETFs, index funds, precious metals, and real estate?
Do you know how to compare two assets that are similar?
Before you start investing, you’ll need those talents.
If you’re not sure about something, I recommend picking up an investing book and reading it thoroughly before making any financial decisions.
The Bogleheads’ Guide to Investing by Larimore, Lindauer, and LeBoeuf is my personal choice for a great all-in-one investment book.
It’s a fantastic one-volume investment book because it relates real-life issues and aspirations to investment options and explains how different options function and fit those concerns and goals.
Even if you want to delegate your investing to an investment advisor, you should still take the time to learn about the investments in which your money will be put.
Putting your trust in someone else to handle it is almost always a bad idea.
- You’ll need a bank that can easily handle online banking and automatic transfers.
This should go without saying for most people nowadays, but it bears mentioning.
Before you start investing, be sure your bank has the tools you need to handle online banking and set up automatic transfers to and from the bank.
If your bank does not provide these services, consider switching banks.
The truth is that most banks now provide these services.
Automatic transfers to and from checking accounts, as well as robust internet banking, have become almost normal in recent years.
Banks that do not provide these services are consciously putting themselves out of business.
What makes these characteristics so crucial?
For starters, if you want to put up any kind of regular investing strategy, you’ll need to establish automated transfers.
You want your strategy to run on autopilot, therefore automation is a crucial part of investment success.
You’ll also want to be able to check on a frequent basis to ensure that money is being transferred out of your accounts, which you’ll be able to do using internet banking.
Start looking for a new bank if your current one makes any of these things difficult.
- You Will Require a Social Circle
While it’s critical that you have a mindset that’s focused on your net worth and optimistic about making wise financial decisions, you should also bear in mind that your immediate social group has a big influence on you. It will be much more difficult for you to make those types of commitments if they aren’t dedicated to those things.
Take a look at your circle of friends.
Who are the folks you hang out with the most, especially when you’re not at work and have the flexibility to do so?
Are those individuals concerned about their financial well-being?
Do they make wise financial decisions?
Or do they always seem to be buying new items and talking about them?
If you’re part of a social group that never thinks about wise personal finance and is always talking about the latest goods and bragging about their latest purchases, you should seriously consider changing your social circle.
Spend some of your leisure time with folks that have a more positive financial outlook.
Find an investment club on Meetup, or simply form new friendships with people you’ve never met before.
Over time, you’ll develop new relationships that are supportive of your financial development.
- You must have a healthy relationship with your desires and wants.
This is the last and most important approach for preparing to invest.
You must have a firm grasp on your desires and wants.
They should not be ruling you; you should be ruling them.
It’s natural to crave stuff from time to time.
That’s just the way people are.
We see delectable meals, fine wines, and goods that are relevant to our hobbies and interests, and we desire them.
So, what are we going to do now?
Do we go ahead and purchase that item as soon as we can?
Do we pretend to think about it for a time before making a purchase?
Or are we patient with our desires, giving them plenty of time to pass before evaluating whether or not they are worth pursuing?
One of the most effective weapons in an investor’s toolbox is impulse control, and one of the most obvious ways to see if you have it or not is when you’re evaluating purchases you want to make.
Do you possess the self-control required to resist giving in to every passing desire?
If that’s the case, you’ll not only have the resources you need to invest, but you’ll also have the self-control you need to ride out the market’s ups and downs.
I’m always surprised by how many people want to jump into investing without possessing all of the items on my list. Whether they want to admit it or not, they’re making a mistake.
I understand why people want to start investing, of course. On programs like Fox Business Network and CNBC, they hear all of the positive spin on investment. They become enthralled by the prospect of a large return on their investment. They are constantly hearing about how the stock market is up 1% today, and they are eager to participate in such profits.
But there’s always a catch, and the catch is that if your foundation isn’t in good shape, any structure you construct will tumble to the ground.