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Successful investment usually involves letting your money work over time. If you are not ready to invest before you get started, you are setting yourself up for failure. There is a certain amount of risk involved with investing so you want to be sure you're putting your hard earned money in the right places. Not understanding the market, investing for the wrong reasons, and even not having the cold hard cash to do so can land you in some hot water of the investment world.
You have unpaid debt.
Because student loan debt is so common now a days, but the interest in investing is also increasing, you'll often wonder if you should invest or pay off debt. If you have a massive student loan debt or high interest credit card debt, you should focus on paying that off before investing. You might end up paying more in interest than you earn on investments in the same period, so your money is better spent to pay off debt. If something catastrophic were to happen with your investment, you will recover much more easily if you don’t have debt that you are also trying to pay off.
You earn equal or less than what it costs to live.
This should be a no-brainer, however it is a common investment mistake. The money you invest won’t be accessible to you as it earns, so it should be money that you don’t need. You need to be consistently earning more than you spend every month. You should not be dependent on credit cards. Set some extra money aside each month and earmark it for investment. If you can contribute money to this fund several months in a row without missing it, then you can start considering investing it.
You do not have an emergency fund.
Your financial situation can change in an instant if you get injured, disabled, laid off, or any other of a million scenarios in which your income changes or stops. Before you consider investing, you should have an emergency fund built up that will keep you and any dependants that you have afloat financially for about six months. Take advice from the experts: even traders are equipped with an emergency fund. This money should be kept in a financial instrument that can easily be converted to cash, like a savings account (high interest if possible), or a Money Market Fund. The easiest way to build up an emergency fund is to set up an automatic transfer for a set amount each month from the account where your paychecks are deposited to a designated emergency savings account.
You do not have health insurance.
If your employer does not provide health insurance, it should be worked into your budget before you consider investing. Failure to have adequate insurance before investing could result in your investments being wiped out or you could be put into a massive amount of debt. When calculating how much you will need in your emergency fund, be sure to take into account the fact that if you get laid off or can’t work, you will lose your employee health insurance, and will then have the additional expense of insurance for yourself and your dependents.
You have not talked it over with your spouse or significant other.
If you are married or sharing financial responsibilities with someone else, you should definitely discuss potential investments prior to making any decisions that could impact both of you. Even if you live with someone else and share rent responsibilities, it’s important to keep in mind that if you invest unwisely or before you are ready, you could cause problems for others if you are unable to pay rent and other bills. You and your spouse or significant other should be on the same page about both your short-term and long-term financial goals, and how you plan to achieve them. Financial issues and disagreements are a leading cause of divorce, so avoid potential strife in your relationship by involving and listening to your significant other in any major decisions.
You do not understand the market.
Investing money is risky, and there is always the potential for financial disaster. You can mitigate some of the risk by diversifying your investments, but you can never completely eliminate risk. If you don’t have a firm grasp of how the investment market works, you should not risk your money. Spend time familiarizing yourself with market trends and investing strategy.
You don't have a budget.
If you don't understand the ins and outs of your current financial situation, you are not ready to start investing. You should have a firm grasp of all your money coming in and going out. Savings should be properly allocated to an emergency fund, retirement accounts, college savings accounts, and other short- and long-term goals. Only after that should you consider it a good idea to invest any leftover savings.
You're investing for the wrong reasons.
If you're investing with the hopes of saving for a vacation or for a home, you're not ready to invest. Investing in the stock market is purely a long term play. For example, saving for a down payment for a home or vehicle may take six months to two years. On the other hand, saving for your retirement can take 30 to 50 years. The reason to not invest in the stock market for short term goals is that returns are not steady and are not guaranteed. There are times when you will need to ride out a 20 percent or more downturn.
You don’t have an objective for investing.
Where and how you invest your money depends on what your objective is and how comfortable you are with risk, based on your current financial situation. Here is a basic breakdown:
- Short-term: Less risk, less reward. If you will need to access your money soon, for instance if you are approaching retirement, less risky investments make the most sense. Safe financial instruments like bonds are the best option if you have a short-term or upcoming financial goal.
- Medium-term: Moderate risk, moderate reward. If you are not near retirement age and don’t need to access your money soon but you want to manage risk, buying a mix of diversified stocks will be your best bet. This way you will have some stocks in companies that pay out dividends and some stocks in companies that reinvest earnings in its future.
- Long-term: High risk, high reward. Aggressive investments are appropriate if you can afford significant risk with your money. You will want to invest primarily in companies that reinvest earnings in its future. It can take a long time for companies to grow enough to significantly increase the value of their stocks, but the potential earnings are huge—think Apple, Microsoft, etc.
If you are not sure which option is the best one for you currently, you need to do more research and consult with a financial adviser to determine your best investment option. Alternatively, real estate may be a better investment vehicle for your needs.
You don't know all of the risks involved.
Most people understand that the stock market goes up and down. Most people, especially those who aren't ready to invest, don't understand that it's possible to lose all of your money if a company you invest in goes bankrupt. One only needs to look at the demise of several banks and investment banks during the financial crisis in 2008.
Beyond that, there can also be liquidity concerns. Some companies don't have a large volume of trades happening each day, meaning it could take days or weeks to sell all of your shares. This is a minor risk, but one to consider. Compared to investment property, for example, stocks can be considered more liquid.
Investing can be a very exciting and rewarding endeavor when done properly. Although you can never completely eliminate risk, you can prepare yourself financially and invest responsibly to be as smart as possible with your money.