How do you know if you’re ready to start investing?

There are 3 things you need to do before you start investing. 

#1 Build an Emergency Fund

An Emergency Fund is a lump of money that you set aside and only use for emergencies. It’s a buffer to make sure that if something unexpected happens in your life, such as losing your job, your car breaking down, or your house needs repairs, you have money set aside to cover it. 

Since the value of your investments will fluctuate day to day, having to take money out of your investments when you’re in a pinch is never ideal. There can also be tax implications to taking money out of your investments (we’ll cover this in detail later on), and it can take several days to process your withdrawal request. Therefore, the money that you keep in your Emergency Fund should never be invested in the stock market, and should instead be kept in a savings account, ideally a high-interest savings account. 

The amount of money that you keep in an Emergency Fund depends on your living situation. In general, most advisors recommend setting aside 3-6 months of your living expenses. While many people are comfortable having this limited amount of money set aside, there are a few situations where having 6+ months of living expenses would be best. 

For example, if you own a home, particularly a home that is likely to have some emergency repairs pop up unexpectedly, like older homes or fixer-uppers, having more than 6-months of living expenses set aside may make sense. Other common scenarios that might make sense for a large Emergency Fund include if you or your partner has a freelance job or unsteady work, or if you have dependents who may need unexpected medical expenses, such as a child or an aging parent. 

Ultimately, your Emergency Fund should be as big as you need it to be for you to feel comfortable “semi-locking” other money away for investing (invested money isn’t technically locked away, it’s just not ideal to take it out if you don’t need to). 

To make it super easy for you to calculate your Emergency Fund, we created a free tracker! Click here to access it <link to EF Tracker/subscription that opens in new tab so they don’t lose their place>

#2 Pay off any High-Interest Debt

You absolutely must pay off high-interest debt, such as credit card debt, before you start investing. Low-risk investing will grow your money by about 8% per year on average. If you have debt with an interest rate higher than 8%, you’ll be earning less through investing than what you would’ve saved if you put the money instead towards your high-interest loans. If you have loans that have an interest rate below 8% but not super low (5-6%), you may opt to finish paying off that debt before you invest, or you might start investing while continuing to pay off your loans. If you have very low interest debt (<4%), it’s often recommended that you start investing while continuing to make your monthly payments since the money you’ll make from investing is much higher than the money you’d save on interest from paying off the loan early. This is also true for mortgages, but we’ll dive more into that later on. 

#3 Understanding your Saving & Spending Habits

Before you begin investing, it’s important to make sure that you’re consistently spending less money than what you bring in each month. If you spend more than you save, you’re actually going into debt. 

The easiest way to check this is to go through your bank statements and credit card statements from the last few months. If you have irregular spending habits and tend to spend quite differently from month to month, you might want to go back as far as 4-6 months to get a better understanding. Add up the total amount spent each month (plus an estimate of how much cash you would have used) and subtract it from how much money you earned that month. Note that your monthly income should be after tax (the amount that ended up in your bank account, not the large number on your paycheck that hadn’t taken out taxes and deductions yet).

If you find that you’re consistently spending less than you bring in, you’re ready to start investing! If your monthly savings are lower than what you want it to be, now is a great time to draft up a budget plan to help you achieve it. Note that there are so many ways you can create a budget, so you can make it as detailed or broad as you’d like! 

If you find that you’re not currently saving money each month, it’s likely best to reflect on how you can reduce your expenses, increase your income, or be more mindful of your spending and make a budget plan before you begin investing.