Investing Precautions
Social media and the internet have done a great service to raise awareness of the importance of investing.
However, it has also incited an over-eagerness for people to start investing. Consequently, people often start putting their money into the markets without having squared off some key areas of their finances first.
This article describes 5 major aspects of one’s finances that they need to get in order, before starting investing.
#1: High-interest debt
From a logical, mathematical standpoint, there is no reason to start investing when you haven’t paid off high-interest debts, like outstanding credit card debts.
These debts compound annually at extremely high rates, even exceeding 20%. In contrast, none of the 3 major markets – the stock market, real estate market, or bond market have consistently produced such average annual returns.
Sure, maybe on a really good year, the stock market could rise by over 20%. But that’s neither the average, nor is there any certainty of such outcomes.
Compare that to debt, where the accumulation of interest is always certain. All things considered, there isn’t any reason to start investing if one still has outstanding high-interest debt to pay off.
#2: Emergency Funds
Being forced to liquidate (sell) your investments prematurely to pay your living expenses is a surefire way to lose money.
Markets are volatile, and once you’ve put your money in, the price of your investments may fluctuate greatly. Imagine being forced to sell a stock, bond, or property investment to pay unexpected bills.
The investment that might have compounded and grown ends up being either a loss, or a loss of potential gains. Simply because you didn’t have enough cash set aside to cover any unexpected costs.
Take the Covid-19 pandemic as an example. In the first few months when everything got shut down, a lot of people lost their jobs while investment markets were simultaneously crashing.
This combination likely meant that, without a large emergency fund, an investor who lost their job would likely have to sell their investments at a huge loss to pay for their living expenses.
Evidently, having an emergency fund is one of the most financially prudent measures you can take. It allows you to absorb those financial shocks. This way, you won’t have to sell your investments prematurely just to get cash for your living expenses.
A lot of people recommend saving 3-6 month’s worth of expenses in your emergency fund. Personally, I don’t go for anything less than 6. If the events of the 2020 pandemic have taught us anything, it’s that the world can change as quickly as the flick of a light switch. And you don’t want to be left scrambling for cash in the dark.
#3: Large foreseeable expenses
This one’s obvious, but if there’s a reasonable likelihood that you’ll need the money for some kind of big expense in the near future, it’s probably wise to hold off on investing first.
For instance, home renovations are notorious for going over-budget, veterinary fees can be higher than expected, etc.
Setting aside some cash for foreseeable big-ticket expenses might not always be necessary, but if it turns out to be, you’ll be thankful you did.
#4: Be willing not to touch it for a long time
Shifting to a more psychological aspect, it’s important to really internalise the fact that investments aren’t something to be fiddled with and adjusted as and when we feel like it. In fact, it’s the opposite. Good investing is boring investing, and having that long-term focus is essential.
The late, legendary investor Charlie Munger has a quote:
“The big money is not in the buying and the selling, but in the waiting.“
I think that perfectly encapsulates the mindset of a successful investor. The biggest threat to our investment returns is our own, often irrational behavior. If we’re not ready to leave the invested money and let it compound on it’s own for years, we’re not ready to invest.
#5: Research
At this point, it should go without saying that investing without doing thorough research in advance is not really investing.
If you don’t understand the investment vehicle comprehensively, there’s little distinction between such ‘investing’, and blind guessing. Bad investors hope. Good investors expect.
Unfortunately, many have come under the false impression that investment markets are just a magic money multiplier, and that with the right picks, they can be overnight successes.
Investing isn’t just game of guessing and hoping to get lucky. Though there are different styles of investing, all the successful ones have the same thing in common – a measured, patient approach.
So while it’s good to feel that urgency to start investing and having your money work for you, don’t rush it. Clear high-interest debt, prepare sufficient emergency funds, do your research, and be prepared to leave it to compound uninterrupted over the long term.