Investing is one of the fastest ways to grow your wealth, and if it’s not yet a part of your financial plan, it’s important to take the right steps now so you can work towards becoming a confident investor.
No two people will have the exact same income, values, financial goals, debts, and assets, so therefore, no two people will have the same investment portfolio. It’ important to take a holistic approach and review your financial house and personal lifestyle before making any decisions about investing. Let’s start there.
Here are three questions you need to ask yourself before you start investing:
Debt is anything that you owe to someone else, be it a mortgage at the bank, a car loan, or revolving credit card debt. You can break it down into “good” debt and “bad” debt; good debt is money you borrow with a low interest rate, with which you make a high rate of return, and bad debt is typically consumer debt - money borrowed at a high interest rate with a low return. Each debt will impact your overall financial health, but it's important not to get emotional about your current situation. Debt happens, and I don’t believe in shaming or guilting anyone over their situation.
When it comes to investing, you should have no outstanding consumer debt for two reasons:
1. The interest rate on your consumer debt is guaranteed. Let’s say you are carrying a credit card debt of $3,000 with an 19% interest rate. If you were to pay $300 a month towards that debt, it would take you 45 months to pay it off and cost you an extra $550 in interest payments. It's better to pay that off as fast as possible before you invest so you can then maximize your investment interest.
2. If you were to split your efforts and pay off debt as well as invest at the same time, it will take you longer to see momentum with either goal and you're likely to lose motivation fast.
A good rule of thumb when considering how much debt you can afford is to use your after-tax income (not gross income) and savings for investment set aside.
This is often referred to as an emergency fund that you can dip into when life happens. This is not to be confused with a line of credit or an emergency credit card. This is cold, hard, cash. We all know life will throw you a curveball, and the last thing you want to do is derail your debt-free record by slapping a broken water pipe / new winter tires / laid-off-from-my-job-and-I-need-to-eat on a credit card.
Ideally this emergency fund should be between 3- 6 months of your current income. The best place to keep this cash is in a high interest savings account that has CDIC coverage, which protects your assets up to $100k. I also recommend an “out of sight, out of mind” strategy for this account, for one single reason: you will be very tempted to spend it if you see it. That upcoming wedding in Barbados will suddenly become an emergency, or the backyard patio needs a facelift, and *poof* that money is gone.
Resist temptation and tuck that money away in a hard to access bank account and forget about it. Perhaps have limits placed on the account with co-signature required for withdrawal, or even place a withdrawal limit.
When you invest, you still have access to your money, however it will be harder to access quickly and withdrawing wipes out the effect of compounding interest.
Your short- and long-term investment goals should be clearly defined before you jump into investing. I don’t recommend investing your money if you’re looking to use those funds towards a down payment on a house in the next 3 years. That would be better suited to a high interest, money market fund, or GIC account.
Ideally, investing is for the long-term, and I like to suggest a minimum time horizon of 10 years. There are several reasons for this, but the most important one (in my humble opinion) is the impact of compound interest.
Compound interest is – get this – interest earned on interest. Let’s say you invest $1.00 and you were to earn 10% interest overnight. The next day you would have $1.10. That $1.10 then earns another 10%, and you now have $1.21. It’s like a snowball; it starts off small, and as you roll it around in the snow, it picks up more snow and increases in size, to the point where it can become hard to push. Your money invested gains momentum as time goes on, and grows faster the longer it’s invested. Einstein called compound interest the most powerful force in the universe, and I have to agree.
Mapping out your investment goals as they align with your life plan (because let’s be honest, money is a part of our life, everyday), creates a smooth transition into building an investment portfolio.
If you need some guidance when it comes to getting investor-ready, book your free consultation call with me and we can discuss your concerns.