So you’ve made the decision to try investing for the first time and you’re wondering just how much you should risk in your investments.
Of course, investments can mean a range of things from stocks to real estate to even art, but we’re talking about managing money with regard to buying and trading shares of a company, index fund, ETF, or other security.
While knowing a thing or two about money management might help with getting your feet wet in the stock market, true financial literacy in this area often involves a deeper understanding beyond the basics.
We’re going to discuss what you need to know about personal finance in this area, starting with some advanced tips about saving and what to do with your money beyond that if you choose to invest.
Want to learn about finance but don’t know where to start?
Saving Before Investing
The best investors start out as strong savers.
Savings involves liquid cash reserves that you can tap into at any time and for any reason though, preferably, only in an emergency or fund a major purchase such as a home or, less optimally, a car.
What the right amount of cash savings is for you and your situation depends on a myriad of factors but, most often, savers should aim for six months of combined expenses in one savings account.
More aggressive savers aim for two years of combined expenses not counting savings for, again, major purchases like a home or car. Your savings account is like an insurance policy should things go wrong in life and the money set aside in it is intended to provide you with financial security and peace of mind. Without this, investing is much too risky and might not be the most efficient money management strategy for you at that time.
Paying Off Debt Before Investing
Another consideration beyond saving before investing is whether or not to pay off debts prior to investing. Here, again, there are many strategies out there and equally weighted advice in each column.
There is the debt snowball method, where you pay off your lowest balances first, and there is the debt avalanche method, where you focus on your highest balances on down the line. Beyond these two basic methods, there is dividend investing wherein the returns are then repurposed to pay off debts – typically in the form of a mortgage or student loan. One thing is common to most strains of advice in this area and that is the fact that you should retire any unsecured debts before you start investing. Unsecured debts are things like credit cards and credit lines that carry high-interest rates.
Why should you eliminate these first? Unlike your student loans or a mortgage, unsecured debts typically carry interest rates greater than 15%. That means that any money you save will have to make a reliable return greater than 15% in order to fund debt repayment. Not only is that pretty tough to do on a consistent basis, but also it is certainly not common for someone with no knowledge whatsoever of investing to achieve.
How Much to Invest the First Time and Where
Let’s say you’ve paid off your unsecured debts and you’ve stashed away some cash in a savings account.
Where should you invest your money and how much? Again, how much you invest is dependent upon your situation but we advise that you do not invest so much that it would put you in financial jeopardy or risk your commitments.
In terms of a general goal, most people are advised to save and invest 15% of their take-home so, if you’ve already saved up and retired your credit card debt, you could take 15% of your paycheck and stash it away every pay period into a stock. If you’re more aggressive, you could aim for 33% or one-third of your take-home pay but, again, caution, in the beginning, is often the most prudent route.
What should you buy? It is probably best to stick to low-cost ETFs that act similarly in terms of mechanics to index funds.
As you accrue more experience, you can move on to individual stocks and perhaps even other securities. Mutual funds and the like tend to be quite expensive for beginning investors though there are options out there available if you want the experience to be totally hands-off but, in a world with investing apps everywhere, it is quite cost-efficient to go that route and sack your money away into an established ETF.