It’s important to understand the basics of investing in order to decide whether to begin investing now or later. Consider your individual circumstances and goals, and then create a strategy that works best for you.
We’re going to guide you through the process of when to determine you’re ready to invest, how investing early can benefit you, and how you can get started!
Debt vs. Investing
If you want to begin investing, it’s important to build a plan your budget can sustain. Investing too much too soon may be burdensome if you have debt. It might be better to pay off your debt first to have more cash flow that can go towards your investments.
Paying off debt first is a common concern investors worry about – which should you do first? Paying off debt can actually pay off in many ways. A U.S. News Money article on the topic of investing states that paying off debt first might improve your overall credit score because you reduce your debt to income ratio.
However, if the majority of your debt is student loan debt, the article recommends you invest now because student loan debt is considered “good” debt and typically involves low interest loans with multiple payment options.
Keep in mind everyone’s situation is different. Your student loans may have higher interest rates, and it only pays to focus on investing if you’re actually going to invest the money. If you stop paying extra on your student loans and use that money for entertainment instead, that’s not going to improve your financial situation.
Additionally, paying off debt can actually net you a greater return, especially when you have high interest rates. Think about all the interest that’s accruing on your debt – you’re getting a guaranteed return when you pay down your balances because you’re reducing the amount of interest you’re paying.
What to Do Before Investing
Before you begin investing, it’s a good idea to have emergency savings built up so you can focus on building wealth without worrying about life getting in the way. If your money is tied up in your investments and you don’t have enough liquidity, you could not only go into debt, but incur fines if you have to withdraw from your investments too early.
Make sure you have enough saved up for a rainy day so you can rest easy and let your investments grow.
Before you invest, you should also consider what you have set aside for retirement or your children’s college savings plans. While these are also considered investments of sorts, it’s important to max out your contributions if you are able to before you begin to invest in other types of funds.
Now that you have enough saved up in your funds, have debt paid down or reduced significantly, and have begun to put money aside for retirement and children’s college savings funds, it’s time to invest and take advantage of compounding interest.
What is Compounding Interest?
Compounding interest is the concept that the interest on your investments also gains interest, which allows your wealth to grow faster. The earlier you are able to invest, the better off you will be in the end.
On the Darwin Finance blog, the author quotes an investment broker as saying, “If you started investing at age 25 and put the same amount of money into stocks until age 35, you’d have more money at retirement than if you started saving at 35 and invested the same amount of money in stocks EVERY YEAR until retirement.”
While this statement might seem outlandish, it’s true that earlier investors can take advantage of compounding interest in a way that late investors cannot match.
Not convinced? Take a look at these charts from Business Insider that show just how powerful compound interest is.Is it worth #investing earlier? If you want to take advantage of compound interest, yes! Here's how. Click To Tweet
How Do I Start Investing?
If you have a little set aside for investing, you have many options you can pursue. Those may include:
- Mutual Funds and Bonds: This type of investment can be purchased through brokerage firms, which often have low minimums, making it easy for novice investors to get started.
- Stocks: Depending on your goals, you might work with a full-service stockbroker or a discount stockbroker. Full-service stockbrokers often work with clients with higher net worth, while discount brokers may be a better fit if you have a smaller amount to invest in the beginning.
- Exchange-traded funds (ETFs): Gain exposure to the stock market without choosing a specific stock by trading in a ETF, which allows you to invest small amounts on a periodic basis.
The minimum amount you are able to invest can vary. However, it’s a good idea to begin with at least $1,000. Do your homework and research the minimum account balances for the investments you’re considering before you pull the trigger. Maybe the next step is to learn how to trade FX (currency trading).
As with any type of investing, it’s important to understand how fees are generated so you know what to expect. Every time you purchase an investment, you also incur commission fees and trading fees. While these fees can vary, it’s important to understand what percentage of your investment will go to fees versus the payoff for the investment.
Mutual funds and bonds may also incur fees. According to an Investopedia article for early investors, the management expense ratio (MER) is charged each year based on the amount of assets in the fund. Early investors may see mutual funds and bonds as a better investment due to dollar cost averaging because regardless of what you put into the mutual fund, the fees are the same.
In other words, the entry level into investing can be less burdensome with these investments.
ETFs may also have fees, depending who you work with, but always look out for the MER on the funds you want to invest in. For example, Vanguard has some of the lowest expense ratios around, and they don’t charge account service fees when investors sign up for electronic statements. However, Vanguards minimum investment amount is $3,000 for a new account.
It’s important to read your documents carefully and discuss any concerns you have with your broker or financial advisor before you invest.
Investing can be tricky, but it’s important to have a plan. Once you’re comfortable with your budget, have debt paid off, or at least a lower amount of it you can manage, and have a good start on your retirement and college fund savings, it’s easy to begin investing. However, don’t wait too long! The sooner you can take advantage of compound interest, the better your portfolio – and your future financial health – will look.