Five signs you're ready to invest
Investing isn鈥檛 for everyone:聽It requires risk tolerance, not to mention money.
It is necessary, though, if you want to turn small, regular savings contributions into a healthy retirement nest egg. Without investing, your savings will actually lose money over time to inflation.
But you can鈥檛 just jump into the stock market without a sufficient financial base, and not all money should be invested. Here聽are聽five hurdles you should cross before you start investing.
1. You鈥檙e taking advantage of a 401(k) with matching dollars if you can
If you鈥檙e offered a 401(k) or other employer-sponsored retirement plan, and your company kicks in matching contributions, you should grab those first and foremost. Often, that match is dollar for dollar up to a certain limit (say, 6% of your salary per year). That鈥檚 free money you just don鈥檛 walk away from聽鈥� and it鈥檚聽an automatic 100% return on your investment.
Because of that, a 401(k) match comes before all of the indicators outlined below; if you have that, you can skip these next steps and start investing immediately聽.
Once you鈥檝e contributed enough to earn the full match, you can take care of these next steps before investing further.
2. You have paid off any high-interest-rate debt
Investment returns ebb and flow depending on your particular asset allocation (we鈥檒l get to this in a minute) and market fluctuations. But it鈥檚 generally considered safe to assume an average annual return of 7% over a long period 鈥� for instance, the path to retirement.
That means if you have debt carrying an interest rate higher than 7%, it makes good sense to pay it off before you start investing. The logic: You鈥檙e paying more to carry the debt than you鈥檇 earn by investing money that could go toward getting rid of the debt.
鈥淐redit cards and lines of credit are usually high-interest debt, while car loans, mortgages and student loans are often at lower fixed rates,鈥� says Katie Brewer, a certified financial planner in Garland, Texas.
3. You have an emergency fund
An emergency fund is money in the bank that keeps you out of a jam if the unexpected pops up: You lose your job, your car needs new tires, the pipes in your house burst during a deep freeze.
Whether you should聽聽is up for debate, but there鈥檚 not much argument about the importance of having this money set aside 鈥� the alternative, in many cases, is running up costly credit card debt. You want to have a fund in place before you start aggressively investing for other goals.
鈥淭ypically this fund should hold at least three to six months鈥� worth of living expenses,鈥� says Brent Dickerson, a certified financial planner in Lubbock, Texas. 鈥淭his is the time period it typically takes for someone to gain employment after a job loss. It makes little sense to invest for the long term 鈥� greater than five years 鈥� if you have to liquidate too soon to cover expenses鈥� when an emergency pops up.
4. You鈥檝e outlined your goals (and they鈥檙e more than five years away)
Before you start investing, you need to know what you鈥檙e investing for. Why? Because, as Dickerson noted above, money for goals that you plan to achieve in five years or less doesn鈥檛 belong in the stock market.
鈥淚magine it is 2007, the stock market is at its peak and you invest your savings to buy a house in 2008. Then, a few months later the great recession hits,鈥� Dickerson says. 鈥淵our savings are now down 60% and you either have to sell at an all-time low or wait multiple years before you see your savings return to the price at which you bought.鈥�
That鈥檚 not a decision you want to make. Money for short-term goals like a home down payment or next year鈥檚 summer vacation should be held in a savings or money market account (go online,聽), CDs or聽.
5. The words 鈥榓sset allocation鈥� mean something to you
You don鈥檛 just want to invest; you want to invest wisely. That means knowing what your asset allocation should be. Those two little words mean combining factors like your goal, time horizon, risk tolerance and investment selection to help you decide how to spread out your money among your various investment choices.
Those choices include stocks 鈥� both U.S. and international, from large companies and small 鈥� bonds and alternative investments such as precious metals and real estate. All are typically purchased by way of聽.
If you鈥檙e unsure about how to allocate your assets, a general rule of thumb is to subtract your age from 110. The resulting number is the percentage of your money that should be invested in stocks (also known as equities); the rest should be in fixed-income investments such as bonds. But that鈥檚 a very rough approximation. If you can swing it, you鈥檙e better off launching your investing career by working with a聽聽(even just briefly) or using a聽.
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