Before You Invest: 4 Must-Haves for Financial Success

Hi Reader,

Welcome to The Money Series and if you are new here, thank you for signing up. Personal Finance can feel ambiguous and overwhelming, but I am here to help simplify the journey.

Over the past few weeks, we have looked at saving smarter and cutting down on wastage. I want to switch gears today to focus on multiplying money through investments. Before investing, we have to ensure you’re set up for success by ticking off a few key boxes.

Do you have an emergency fund?

As I explained here, you should have a separate emergency fund distinct from your savings and investments. The fund will allow you to take care of emergencies (obviously) and any unplanned spending that may arise. You don’t necessarily need the recommended 6-12 months of emergency savings right away, but you need a plan to get there. Why is this important? Some investments may include a lock-in period during which you cannot withdraw your funds and if that’s the only investment you have, you won’t be able to take care of emergencies. Also, investments involve risks – one major risk is that your investments may decline in value – you may want to hold on till the market recovers and not sell at a loss to cover an unplanned expense. Think of it as your financial bulletproof vest—it’s better to have it and not need it than the other way around.

Do you understand the risk-return dynamics in investing?

You may have noticed that different financial products have different returns. The main reason for this difference is the level of risk involved in the assets. An important principle of investment is that higher returns entail higher risks. Risk explains the reason that the actual return of an investment can differ from the expected return. In investing, there is no reward without risk.

See, investment products lie along a spectrum (a risk-return spectrum, if you may). On one extreme we have fixed deposits that are considered very safe with very low risk and hence, low return on investments. On the other end of the spectrum, shares/stocks have the highest expected return because they are considered risky assets. There are other assets in between both extremes.

Before you begin investing, you need to assess your risk appetite and in doing this, there are 3 things to consider – Need, Ability, and Willingness.

Needs – how much do you need and by when? If you want to retire early, you’ll likely need to aim for higher returns and take on more risk.

Ability – how much risk can your finances handle? Do you have dependents or high living expenses? If yes, your ability to take risks is possibly lower than that of someone with no dependents or lower expenses. Therefore, you may need to lean toward safer options.

Willingness – Even if you have the need and ability, can you stomach the volatility? If a dip in the value of your portfolio makes you panic or keeps you up at night, then your willingness to take risks is probably low. Lower-risk investments might be better.

Are you ready to invest for at least 3 – 5 years?

Investing is a marathon, not a sprint. Generally, you should leave your investments (especially stocks) in for at least 3-5 years before you withdraw any funds, and this is for several reasons. First, the stock market is quite volatile in the short term with price fluctuations due to business cycles and other market-specific events. Investing for longer allows for the market to recover from short-term losses and generate positive returns. Also, the market has historically demonstrated positive returns over longer periods. A 3 – 5 year timeframe increases your likelihood of benefiting from this trend as it smoothens out the downturns, as opposed to being adversely affected by short-term sell downs. When you decide to invest for longer, you become less worried about the daily movement in the value of your investment as you focus on the big picture.

Do you hold significant short-term debts with high interest rates?

Before you start investing, take a hard look at your debt situation. High-interest debt like credit card balances or payday loans can drain your finances faster than investments can grow them. Here’s the math:

• The average return on the S&P 500 is about 10% annually

• High-interest debt can cost you 15–20%—or more in interest.

Inherently, the rate on these short-term loans exceeds the returns you may obtain in the market, and you are better off focusing on paying off the debt first before you begin investing. While the debt and interest payments are certain, the return on investments is, at times, not guaranteed. Hence, you may lose money on your investments while still in debt. In addition, paying up the debt can free up more cash flow for you to boost your investment balance comfortably.     

So, how did you do? Are you ready to start investing, or is there some work to be done?

Did you hit all four? Reply to this email to leave me a comment!

Act Now: 

• Check if you are aware of all four and have answers to them

Reflect on This:

• Which of the above is new to you and what’s your next action?

Till next week, I am rooting for you, money-ly!

Dee           

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Disclaimer: This does not constitute financial advice. Please conduct your research or consult your financial advisor for important financial advice.