Investing in the stock market can build wealth towards financial freedom, … [+]
According to a recent Bankrate survey, more than half of working U.S. adults say they are behind on their retirement savings, with 37% saying they are “significantly behind.”
I’m a debt-free millionaire and soon-to-be retiree who teaches financial freedom habits to people who feel like they’re not reaching their money goals. Unfortunately, I’ve found that many people try to supplement their retirement savings by investing in the stock market before they can afford it.
The stock market can be a powerful vehicle for building wealth, but there’s no guarantee that you’ll make money, especially if your underlying financial stability doesn’t allow you to invest for the long term.
Here are five important steps to take before making your next stock market investment: These habits helped me, as a first-generation Filipino-American woman and self-taught financial savvy, save and invest over $1.7 million by the time I turned 40.
Keep one month’s worth of expenses in a regular checking account
A good cash flow buffer is to keep a month’s worth of living expenses in a checking account that you use to pay your regular bills. This way, you’ll have easy access to cash for everyday expenses and your bills will be paid automatically, without having to dip into your savings or investments.
Not only will this help you focus on learning the new skills you need to be a better investor, but it will also help you break out of “payday living” by keeping track of your monthly expenses up front.
Save a “what if” fund in a high-yield savings account
In addition to your cash flow cushion, I also recommend setting aside an additional month’s expenses in a high-yield savings account. I don’t call this an emergency fund, I call it an “if something happens” fund, because it doesn’t have to be a life-or-death event for you to need to access this financial safety net.
Even if they aren’t serious, it’s best to assume that unexpected events will occur periodically. Having a buffer against unexpected expenses not only gives you peace of mind, but also allows you to afford losses in your investments without putting your everyday necessities at risk.
I especially recommend high-yield savings accounts because many offer around 5% interest and, as long as the bank is FDIC insured, you can grow your cash without taking on too much risk.
Maintain a monthly budgeting routine for at least six months
Unless you’re willing to commit to a monthly budgeting routine for at least six months, you’re not going to have the patience or discipline to become a strategic investor. Understanding your spending habits and taking control of your finances is essential to identifying areas where you can save to increase your investments in the future.
I have been budgeting consistently every month since 2016 using three basic categories. This consistent habit has helped me identify excess funds that I can risk in the stock market without worrying about whether the bills will get paid. Consistent budgeting is the foundation for building a strong financial foundation before investing in the stock market in earnest.
Eliminate all credit card debt
I get asked the same question all the time: Should I pay off debt or should I invest? If that debt is credit card debt, focus on paying off all your credit card debt before investing more in the stock market.
Credit card debt often comes with high interest rates of 15% to 25% or more, and even a high-performing stock portfolio will only provide average annual returns of around 7% to 10% — and that’s if you know what you’re doing.
It’s a matter of simple math. The interest you pay on your credit card debt can far exceed the returns you make on your investments, leaving your overall financial situation in a net loss. It’s unlikely you’ll ever see returns in the 15% to 25% range in the short term, especially if you’re a beginner investor. Eliminating credit card debt will free up even more cash flow for future investments.
Open an Individual Retirement Account (IRA)
Consider opening an Individual Retirement Account (IRA) to take advantage of tax benefits that can help you grow your retirement savings more efficiently. Investing in an IRA can save you significant amounts of tax on stock market investments, and early withdrawal penalties can motivate you to stay invested for the decades it takes to see meaningful returns.
Investing in the stock market is risky, even more so if you don’t have a solid financial foundation. Following these five steps can help you gain the confidence you need to make stock market investing a long-term habit rather than a short-term fix.
