A guide on things to do before you start investing for Newbie Investors: So, you’re thinking to start investing. But before you enter, are you prepared? Do you actually meet all the requirements that will make your investment journey smoother? In this post, we’ll discuss seven such things that you should do before you start investing.
7 Things to do Before You Start Investing
1. Build an Emergency Fund
As the name suggests, an emergency fund is a money that you put aside for emergencies. It is the money that you can reach out to during your hour of need and pay for those unforeseen and unexpected expenses such as loss of a primary job, medical emergency, personal emergencies, or even a car breakdown.
As a thumb rule, before you start making investments for your long-term goals, first you should build an emergency fund that should be greater than at least three times your monthly expenses. Keep this money aside in a separate account. You can read more about how to build an emergency fund here.
2. Have a Budget & Know Your Cash-Flows
If you want to enjoy a healthy financial life, it’s really important to have a balance between your savings and your expenses. Budgeting your monthly finances and knowing your ‘cash’ inflow and outflow can help you plan how much you can afford to invest per month.
A simple profit and loss formula that you can use in your day-to-day life to understand your cash position is ‘Revenue — Expenses = Profit”.
Here, your total revenue (inflow) is the sum of all the income that you make from different sources like your job, business, interests on savings/fixed deposits, dividends, rental income, etc. And your total expenses (outflow) include your rent, groceries, transportation, bills, EMI’s, household expenses, etc.
When you deduct the total expenses from your net revenue, you’ll be able to find out how much you keep per month or year. And after calculating this, you can plan where to allocate this money and how much to invest in different investment options.
Note: If you are struggling with your personal budgeting, one of the easiest strategies that you can use to figure out how much should you save is the 50/20/30 Strategy.
50/20/30 is a really simple and straightforward budgeting strategy that can help you to define how much should you spend on your essential spendings (needs), savings, and finally on your preferences (wants and choices). According to the 50/20/30 strategy, you should allocate:
- 50% of your monthly income on ‘Needs’ (like rent, food, etc)
- 20% of your monthly income on ‘Savings’ (like your retirement fund, investments, etc)
- And the remaining 30% of your monthly income on your ‘Wants’ (like traveling, dining out, etc)
You can read more about the 50/20/30 budgeting strategy here.
3. Pay Down High-Interest Debt
First of all, please note that not all loans or debts are bad. Here, we are talking about high-interest debts. For example, if you have taken a personal loan, its interest rate may vary from 13–18%. Similarly, a credit card company may charge you even higher interest on the outstanding amounts.
It doesn’t make much sense to invest if the profits that you make on your investments are lesser than the interests that you pay on your debts. For example, if your returns are 12% and you’re paying 14% as interest on your previous debt, then overall you’re at a loss. Here, instead of investing, it will be better to use that money to pay back and become debt-free.
Before you start investing, try to minimize or eliminate debt, especially high-interest debts and your credit card debt. These interests can kill your investment profits.
4. Take a Health Insurance
When people are in the best of their physical health, an obvious question among them is why should they invest in health insurance? Paying a premium plan for ensuring health may seem an unnecessary expenditure.
However, accidents or health issues may come up anytime unexpectedly which can put a lot of financial and mental pressure. Further, it is a fact that, as you grow older, health issues come along with it. And hence, it is highly necessary to incorporate healthcare planning within the budget of your family’s financial planning.
Before you start investing, make sure to take health insurance first. Being medically insured can help you avoid facing financial instability in the future and enables you to get the best health treatment.
5. Define Your Goals and Make Plans
One of the most critical things to do before you start investing is to define your investment goals/priorities and making plans to reach them. Here, you need to know why you are investing. It will keep you motivated and ‘on track’ to achieve your goals.
Now, by definition, an investment goal is a realistic expectation to meet the returns by investing predefined money for a fixed time frame. The keywords to note here are ‘realistic expectations’ and ‘timeframe’.
Before you put your money in any investment options, set your short-term and long-term goals and make plans for how you’re gonna achieve them. The goal can be person-specific like planning for children’s education, retirement fund, buying a new house, or even financial independence. Once you’ve set your goal, you can choose the best investment options that can help you reach these goals in your defined time horizon.
6. Evaluate Your Risk Tolerance Profile
Everyone has a different risk tolerance level depending on their age, financial situation, priorities, etc.
If you are young and have a stable job, you might be willing to invest in more unusual ‘high risk, high return’ options. However, as you grow old/retire, you might not have a job or primary source of income and hence you might depend on your retirement fund for meeting your expenses. Here, you may not be willing to take a higher risk and choose safer investment options.
Before investing, you need to define your risk sensitivity i.e. whether you’ve are high, moderate, or low-risk tolerance profile.
As different investment options have different degrees of risks, you can choose your investment options depending on your profile. For example, if you have a high-risk tolerance, you may invest in stocks, mutual funds, real estate, etc. On the other hand, if risky investments keep you sleepless at night, better to choose low-risk investment options like fixed deposits, PPF, bonds, etc.
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7. Understand the Investing Basics
Don’t dive in deep water if you don’t know the swimming basics. Similarly, do not start investing your money, if you do not understand the elementary concepts.
Before starting your investment journey, make sure that you understand what is meant by stocks, bonds, mutual funds, diversification, liquidity, volatility, and other investing basics. Here, you do not need to become a finance geek or an accountant. However, you should have good enough knowledge of the industry to make intelligent decisions.
These days, anyone can open their Demat and trading account with minutes and start investing in stocks, mutual funds, etc. However, it is not advised to do so until you have met the basic requirements and completed a few other essential tasks. In this post, we discussed how 7 must things to do before you start investing. This included budgeting, planning, knowing your risk tolerance, and moreover, learning the basics.
That’s all for this post. I hope it was useful for you. Besides, if you are ready to get an education, here’s an amazing course on stock market investing for beginners that you should check out. Happy Investing.
Kritesh (Tweet here) is the Founder & CEO of Trade Brains & FinGrad. He is an NSE Certified Equity Fundamental Analyst with +7 Years of Experience in Share Market Investing. Kritesh frequently writes about Share Market Investing and IPOs and publishes his personal insights on the market.
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