Investing is the best way to create long-term wealth and financial independence.
If you’re just starting out no doubt you’ve figured out that it can be confusing at first. There are lots of decisions to make so it’s important to make sure you’re prepared to give yourself the greatest chance of success.
With this in mind, here’s the five things we think everyone should consider before investing.
1. Pay off high interest debt
This is a really important one! If you have credit card debt (or any other high interest debt) it’s important to get these paid off before investing. There are practically no investments that can consistently make up for the cost of the high interest rate you’re being charged.
The average credit card interest rate is generally between 15% and 22%. The average return of Australian shares over the last 20 years is 9%.
2. Sort out an emergency / rainy day fund
Before you start investing it’s smart to have money saved for an emergency fund (or rainy day fund). A rainy day fund is cash you have set aside for covering unexpected expenses such as medical bills or losing your job. All the stuff you don’t want to think about.
Money you invest is different to this and should be set aside to leave for the long term, we recommend 3+ years as a minimum to give you the best chance of a good return.
This means you shouldn’t need to touch it until you reach your goal! Returns over shorter periods like a few weeks or months are pretty random so you do really need to invest for a few years to see results.
The amount you need in your rainy day fund differs person to person depending on personal circumstances. We recommend enough to cover at least 3 months of living expenses.
3. Set goals
Disciplined investing is easier when you have some life goals you’re working towards.
It may be a house deposit, travel or just a specific figure you have in your head, setting goals lets you work out exactly how much you need to invest regularly to help you get there in small steps. A well set goal helps you stay motivated and keep your eyes on the prize!
It’s important to stay focused on the big picture and not get distracted in the short-term.
4. Understand your risk capacity and timeframe
Getting clear on your risk capacity and investment timeframe will help you find the right type of investments. When we look at this for clients we consider a bunch of different factors.
1) Your age and life stage 2) How long you’re planning to invest for 3) How gains and temporary losses make you feel 4) Your investment experience
Theoretically the younger you are the greater your capacity to take higher risk as you have the next 30 – 40 years to invest. If you’re a bright eyed ‘millennial’ you can (in theory) invest in ‘high growth’ (ie riskier) investments as you’ve got the luxury of time to wait out market dips in order to achieve higher growth.
Reality check! It’s likely you’ll have a plan to use some of your investments along the way for those life goals mentioned above. So if your investment timeframe is shorter you may need a more balanced approach to investing.
Comfort levels with risk is also extremely important. This is often formed through personal experience which varies person to person (two people at the same stage of life can have very different attitude towards risk taking).
Experience also plays a big part. People who have lived through several cycles of investment markets going high and low and high again, generally have a better understanding that investments don’t always go up. Sometimes you just need to wait it out.
5. Research your options
Finally, there are a lot of options available when it comes to investing. Each type of investment (ie. shares, bonds or gold) has unique characteristics and plays a different role.
Some investments are high growth but higher risk. Others are lower growth (aka defensive) and are lower risk. Smart investors spread their money across lots of different investment options as this can help minimise your losses if the value of one of your investments drops – this is called diversification.
We believe one of the easiest (and best) ways to diversify your investments is through Exchange Traded Funds (ETFs). This is because with ETFs you’re buying shares in many different companies instead of just one (eg. iShares Global 100 ETF invests in the largest 100 companies around the world).
You can also combine different types of ETFs (like shares and bonds) to create a portfolio suitable for market ups and downs.
[Source: Top five things to do before you invest by Chris Brycki.]