If you’ve been working on your personal finance, you’ve certainly heard the advice to invest, invest, invest. However, with so many other factors to consider – debt, savings, income, spending – how do you know when it’s time to start investing?
Should you be investing while you’re also working on other areas of your finances?
If you’re curious about when is the right time to start putting your money to work for you (instead of the other way around), here are some guidelines.
You’ve maxed your retirement contributions
I have some news for you: you may already be investing without realizing it! If you are participating in your job’s 401(k) program, then congratulations, killer. You’re already investing. The money that goes into your 401(k) is used to invest in stocks, bonds, mutual funds, and other investments. You made these selections when you signed up (or were auto-enrolled).
A 401(k) might not feel like “real” investing, because the money goes into the account pre-tax, so you never even see it. And the contributions are invested in things such as target-date funds or equity funds – not something sexy like a new, hot stock.
But really, your retirement account is investing. It’s tax-advantaged, too – which means you don’t pay tax on it until years down the line when you retire and start withdrawing funds.
That’s why it’s a good idea to max out your retirement accounts before you start investing in a regular, taxable brokerage account, where you’ll have to pay taxes on your gains.
If you don’t have a 401(k) and you still want to invest in a retirement account, you can open a Roth IRA (individual retirement account) or a traditional IRA. These are retirement accounts where you get full control over the investments within them. Think of an IRA as an account that can hold all kinds of investments: stocks, bonds, mutual funds, ETFs, REITs, and more. You choose what to invest in, unlike a 401(k), where the plan administrator gives you a limited set of choices.
Roths have an income limit, though, so if you make more than $140,000 per year, first of all, congratulations, and second of all, go with a traditional IRA. The tax details are slightly different (they use pre-tax money instead of post-tax money, so you’ll have to pay tax on your contributions when you retire). However, both kinds of accounts are a great way to shield your investments while you’re working.
If you do have a 401(k), good news: you can open an IRA as well! That gives you additional tax-advantaged investment power.
Your emergency fund is topped up
The next area to consider is your savings account. Do you have an emergency fund? Hopefully, the answer is yes. An emergency fund is what will save your butt if a disaster happens. Whether your cat needs surgery or your car breaks down, things happen, and an emergency fund helps you cover these unexpected surprises without going into debt.
Depending on how stable your job is, try to have between three months and up to a full year of expenses saved up. What I mean by that is, if you lose your job, could you live off your savings for three, six, or even nine months or more until you found a new one?
Many people have been surprised by layoffs. You could be doing a great job, and your boss loves you, but corporate management could decide your department isn’t necessary anymore. You have to be ready for that, even if it seems like an off chance.
If you don’t have an emergency fund in place before you start investing, you’re risking a lot. Imagine it: the stock market tanks, your investments lose 50% of their value (meaning you may have invested $10,000 but now it’s only worth $5,000 if you sell it). Your company is struggling in a bad economy and lays you off. Now you’re not only jobless, but you don’t have $10,000 anymore – the most you could get is $5,000 if you sell your investments, handing you a $5,000 loss right as you start unemployment.
Top up that emergency fund first, and then you can focus on more risky endeavors like investing.
Check out MU30’s emergency fund calculator to learn how much you should be saving:
You’re not carrying a big balance on your debt
OK, so this one is just math. If you are carrying a balance on your credit cards, and you’re paying 17%, 18%, 20%, even 25% interest, your investments are going to have to do SPECTACULARLY to cover for the money you’re losing on interest payments on your debt. That’s a pretty big ask. The market is too unpredictable.
The same goes for any other high-interest debt, such as personal loans. If your interest rate exceeds your returns on your investments (and at some point, it will), then it doesn’t make sense to put money into investments before you pay down your debt. Get that debt paid down and you’ll free up more cash for your investments – without feeling pressured to make some risky investments to make up for it.
You know your diversification from your dividends
You don’t need to sit around trading derivatives, yelling about option swaps, and chasing alpha on your day trades while remaining glued to your stock app of choice.
However, before you invest, you should be reasonably well informed about the stock market, about various kinds of investments, about the fees and taxes you should expect, and about general current events, financial markets, and economic trends.
Hiring a great financial advisor can be a shortcut to this kind of investing knowledge, but that’s not your only route. You can learn a lot about investing on your own – and it’s actually a good idea to do some of your own learning, so you’re not as vulnerable to someone else’s ideas and opinions.
Start with the basics, if you don’t have them down yet:
- How the stock market works.
- The difference between stocks, bonds, and other investments.
- The difference between taxable and tax-advantaged accounts.
Then explore some trading strategies. Do you want to be an active trader, or are you good with passive investing? In other words, are you comfortable enough to track prices by the day or hour, jump on deals, and execute trades? Or would you be fine with a “set-it-and-forget-it”, long-term strategy? You have to know your own personality, time commitment, risk tolerance, and general attitude to make that decision.
And whether you choose an active approach or a passive one, you’ll need to know current market conditions, current events, and business basics to understand your trades and reasonable expectations of their performance. Financial news sites can help you get up to speed.
You’ve set goals
When you hear news stories about crazy-big “wins” in the stock market, it’s easy to think, “why not me, too?” But before you start investing, you should set some more specific goals than simply “make tons of money.”
First of all, there’s no guarantee you’ll make tons of money. You could get lucky and pick a stock that goes up 200% – or you could get unlucky and pick one that drops just as much.
It’s better to set some specific goals, ones you can measure, and then make a plan. After all, you don’t control how much a stock appreciates; you only can control your own actions.
Long-term goals work well for the stock market, which tends to go up over time but contains some real heart-stopping losses along the way. It’s why retirement accounts have such long time horizons. You may see ups and downs in the short-term, but after 20, 30, or even 40 years, it all typically evens out for the positive, leaving you a bit ahead of where you started.
You have the fortitude to hold on
If you check in on your investments, and you see they’ve dropped, will you have the mental (or emotional) strength to hang in there? Or will you panic and sell?
Investing takes some amount of calm, rational behavior, as well as the ability to think clearly in times of adversity. Unlike when you deposit your money in a bank account (with that sweet FDIC insurance), investing doesn’t come with a guarantee. And it’s very easy to let panic get the best of you, especially when it comes to your life savings.
So, before you start investing, make sure you’ve exercised that restraint muscle. Practice setting goals and sticking with them, even when things get hard. You’ll need to be able to know (or at least figure out) what to do when things don’t go the way you hoped they would.
Ready to start investing? Here are some options
So, you’ve paid down your high-interest debt, fully funded your emergency fund, and re-upped your retirement contributions. You’ve done your research and you’re feeling excited and hopeful. Now, you’re ready to start investing! You have about as many options as there are stars in the sky (it feels like), so where should you begin?
As mentioned above, a great way for beginners to start investing is to open a Roth IRA. You can open a Roth at any number of brokerages, including discount brokerages.
For example, you can open an IRA at E*TRADE with no minimum account deposit. That means you can focus on getting your account set up and worry about transferring funds later.
If that sounds like too much work, consider using a robo-advisor app like Robinhood, where you can be as active or hands-off an investor as you like.
You’ll know you’re ready to start investing when you realize you’re getting the rest of your financial house in order. Once you’ve taken care of the most important obligations – debt, saving, and retirement – you have the wiggle room to put your money to work for you.