Sunday, November 4, 2018

What you should do before you invest

No doubt about it. Investing is essential for your future, especially to prepare for retirement. You cannot rely on government programs, such as social security, for your entire retirement earnings.

I'm telling you this right now: Save and invest until it hurts. But before you actually invest, there are certain things you must do first.

1. Have a fully-funded emergency fund.

Shit happens. It seems to be a law of the universe.

No matter how good you are at planning and preparing, something will happen sooner or later that wasn’t on your personal spending radar. I don’t mean “NFL is starting soon so I need a new TV” – I mean more along the lines of “the water heater just gave out and we need to replace it ASAP”.

These expenses are generally not only unexpected, but they also are time-sensitive – they need to happen “now”. Without an adequate emergency fund in place many people will struggle to cover even a $400 non-budgeted expense.

Financial advisors, financial planners, and just about every financial expert, will recommend having an emergency funds between three and six months worth of living expenses. I just read an article where the new standard is 12 months. If you don’t have an emergency fund you should quickly put together a starter emergency fund of $1,000. Then work toward growing that account into being fully-funded with the target amount you decide.

Not having an emergency fund will get you off track faster than any thing else you do.

2. Know Your Cash Flow (Have A Budget)

Having a household budget allows you to understand exactly where all of your dollars are going each month. Hopefully you’ve trimmed expenses enough, and/or have good enough income, that each month you have significant “extra” cash flow after covering all of your expenses.

Also, as part of your budget, plan for expenses that are not monthly, such as car insurance. I pay every six months instead of monthly, and I save about $100 in premiums. But you have to plan for this.
Here's some articles to help you get started.

Personal budget percentages: Here’s where our money goes

Successful budgeting is all about this one thing

How To Overcome The Top 3 Budgeting Obstacles

3. Pay Off Consumer Debt – Especially Credit Cards

The national average interest rate on credit card debt in early 2018 is just over 16%. Let that sink in for a moment.

Carrying high-interest consumer debt is one of the largest barriers for people who are trying to grow their wealth and achieve financial freedom. Paying off a debt is similar to getting an immediate known gain comparable to the rate paid.

If you have a $15,000 balance (average balance in 2018, according to Schwab) at 16% interest (the average), you’ll pay $2,400 this year in interest payments. Paying that off to save the $2,400 is almost like getting a 16% investment return! If you want to get specific, the comparable gain is actually higher because it probably takes about $3,000 worth of income (pre-tax) to pay the $2,400 interest.

Here's a method I used many years ago to pay off my credit card debt, which was a nauseating $45,000. I also added my car payment to the list. I paid all this off in about three years. Except for my mortgage, I'm debt free. I just bought a 2016 Impala, to replace my 2004 Buick, for cash (Rule 12: never buy a new car). What a wonderful experience.

  • Make a list of all your credit cards and the balances due. Order them by smallest balance first. Put the list where you'll see it every day. Mine was taped to my refrigerator.
  • Put your credit cards away. Do not use them.
  • Pay off the smallest balance first. Cross it off the list. Then start on the second balance.

This is the Dave Ramsey snowball method. I highly suggest it, as it worked for me.

I now use my credit card for convenience. But I pay off the balance every month. I earn points also, so the credit card company pays me to use their card. They probably hate me. So sorry, too bad.

4. Make Net Worth Your Primary Tracking Metric

This may seem like busy work, but it is essential to running your household finances. Run your finances like a business.

If you don't know how to do this, there are many resources on the web. Here's one from Schwab: Your personal net worth.

I still do this on a monthly basis.

5. Clarify Your Goals And Priorities

Managing cash flow (budgeting) is all about balancing priorities – you’re taking limited resources and allocated them to the areas that are most important to you. This exercise is key for your overall financial planning too.

Before getting started on your investing, take some time to think about what is really important to you. Write them down. Have long-term goals as well as short-term goals. Update this regularly.

This seems like busy work, but all successful people set goals.

6. Make Sure You Understand Investing Basics

No one should invest in something they don’t understand. Along that same line of thinking, that means that you should have a basic understanding of general investing concepts. You should know what exactly is a stock, and what is a bond? You should understand the concept of diversification (don’t put all your eggs in one basket). Understand mutual funds, and ETFs, and the difference between them. Make sure you are comfortable with the idea of volatility (fluctuations) and your level of risk tolerance.

Jumping into investing with no idea of what you are doing is very dangerous. Even if you decide to use an investment advisor, you should make sure you understand what they are recommending for you. If something isn’t clear to you, just ask. A good financial advisor or planner is going to take the time to educate you to make sure you are comfortable with the suggestions.

Investopedia has a ton of resources to get you started.

Doing these six things will make a difference in your life. But you have to do it. So do it today. Get started.

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