“Building a Solid Financial Foundation – Before you Invest!”
There is no shortage of advice encouraging you to begin investing at a young age, or at least as soon as possible. This argument is a valid one. The earlier you begin investing, the more time your money is subjected to the positive effects of compound interest, a phenomenon that Albert Einstein supposedly called the “eighth wonder of the world.” I’ll save the benefits of compound interest for future posts, but please keep in mind that regardless of how magical compound interest might seem, it is best to have armed yourself with a solid financial foundation before ever dropping a dime into an investment.
My steps to a solid financial foundation:
- Set short/long-term goals and develop a monthly budget
- Buy adequate insurance
- Stash 3-6 months of expenses in a separate savings account to be used only in emergencies
- Eliminate high interest debt
- Eliminate low interest debt if able to do so in a relatively short amount of time*
* I consider this step optional depending on your risk tolerance and investing style. This step sounds counter-intuitive when looking at the mathematics. For example, I could probably beat the 4% interest rate on my outstanding student loans by placing my excess funds into the stock market, assuming a conservative 8% return. Also, many investors use debt as a tool to increase their wealth. However, there is validity in the psychological benefits associated with being “debt-free,” including a good night’s sleep!
The only exception I have made to financial guideline #1 has been saving for retirement through my company’s 401(k) plan. They currently match 4% of my contribution and I have taken advantage of this “free money.” There are too few guarantees when it comes to investing and the company match is a guarantee that you should almost always take.
