Do These Tasks Before Investing
I get a lot of calls from people looking to invest. Often I see people make the mistake of investing before their financial house is in order. For someone just starting out I recommend completing these tasks before beginning to invest.
Live Within Your Means
Spend less than you earn. If more cash goes out on a monthly basis than comes in then this is the first item to fix. Two ways to do it – make more money or spend less money. It’s that simple. Until you are certain that your ongoing income easily covers your ongoing expenses there is no need to proceed to the next step. Spending more than you earn is not sustainable and will lead to financial ruin in the long-term.
Where should this money go? Any checking account that is convenient for you. Automate as much as possible – have your paychecks directly deposited and sign up for as many automatic bill pays as possible.
Have Adequate Insurance
OK – so your checking account is growing. You are living within your means. The next step I would recommend is to protect the ones you love with life insurance. If you get hit by a bus tomorrow and the income stops flowing in you need a way for your family to cover expenses. That’s where life insurance comes in. However we don’t want any kind of life insurance. Most policies are sold to consumers and come with ridiculous fees and expenses. The only life insurance I recommend is term life insurance. Term life insurance is life insurance that guarantees payment of a death benefit for a specified time period. It is the most simple and affordable type of life insurance. Typically I recommend getting a policy that is good for 20 years in an amount around 10 times your annual income. So if you are 30 years old and make $50,000 a year you would get a $500,000 death benefit that covers you until age 50. One final note – only do this if you have a significant other or children. There’s no need to get life insurance if you are single and have no dependents.
My favorite place to get life insurance is from GEICO.
Build an Emergency Fund
Life happens. I recommend getting an emergency fund set aside in case of a setback. This is for medical emergencies, job losses, or anything that requires funds on short notice.
A good starting point would be to save six months worth of income in this account. So if you make $3,000 a month you would want a minimum of $18,000 in this account.
This fund should be kept separate from your checking account so it’s not sitting there tempting you.
My favorite place to save for emergencies is with a high-yield savings account at Ally Bank.
Need help tracking your finances? Check out our blog on how to budget in ten minutes a week.
Eliminate Credit Card Debt
Credit cards are useful when they are paid off every month.
They are extremely dangerous when not paid down. Anything with an interest rate higher than 8% (think credit cards and payday loans) should be eliminated as quickly as possible.
After building the emergency fund all excess cash should go to paying off all credit cards. If not, they will grow and grow and consume more of your cash flow.
Time to Invest
OK. You’re spending less than you make each month. If you have loved ones you’ve acquired term life insurance. You’ve built an emergency fund outside of your checking account that covers six months of income. And you’ve paid off all of your credit card debt.
Congrats! This is a notable achievement that many people never get to. It can take years to get to this point.
Now it is time to visit our blog: How Do I Start Investing?
Brian Berkenhoff, CFA