Investing right can be a great way to make and grow wealth. If done correctly, in long run, investing can help you achieve your financial goals and even financial independence. The earlier you start your investing journey, the better it is. It gives you much more time to let compounding work wonders for you! However, investing, while important, is not the only goal of your financial journey. Here is a small 3-point checklist I believe, you should tick off before beginning your investing journey.
Checklist before investing – What are 3 things you need to ensure before investing
1 Get rid of unnecessary debt
Debt come in all shapes and sizes.
Many of these debts loans are avoidable. Some like personal loan or credit card debt or consumer loans are usually unnecessary and result of lifestyle. Some, like home loan for primary residence may be a necessity. Most of us may not be able to afford otherwise. Education loan may be unavoidable for many. Car loan can be avoidable in many cases.
You end up paying interest on your loans and debts, which in effect makes you spend more money than necessary for things that may not be too necessary. Barring payment of home loan and education loan, anything else is unlikely to yield any tax benefit.
Let’s consider what happens while you keep servicing the loan (at its regular schedule, not closing it by repaying fast:
- Most of the investment which give more or less guaranteed returns (liquid funds/ fixed deposits/ PPF etc.) are unlikely to give more returns than the interest you are paying on the loan. For example, with current rate of interest, you are will be paying around 12% or so on personal loans in India (much more in credit card debt) or close to 10% on car loan. Most of the debt instruments can give up to 7-8% pre-tax rate of returns (some tax saving instruments can give higher returns – e.g. provident fund gives 8.65%, currently). This is less than the interest you are paying to service the loan.
- Equity markets have given a higher rate of returns historically, in long run, there is no guarantee. So if you are servicing a car loan at 10% interest rate and investing money in equities/ mutual fund expecting a higher rate of returns (say 15%), it may or may not happen. In a way you are taking a virtual debt to invest in equity markets at that point of time. Do it at your own risk if you wish to! (I don’t recommend it) You may end up doing better. You may also end up losing lot of money.
However, for home loan and education loan, you can decide upon the repayment based upon the interest rate difference (between servicing loan & the investments), tax benefits you are getting and your comfort level with reduced liquidity.
I would suggest to pay it off as fast as possible.
2, Have an emergency fund in place
Money is not worth it if you can’t use it during an emergency.
There are many emergencies that require immediate access to money. And it is important to have access to an emergency fund. While you can start slowly (when you have started earning & don’t have much dependents), you need to scale it up when you have dependents.
Investing in your money before having an emergency fund in place can either make it inaccessible in times of emergency (e.g. real estate investment, or investing in tax saving instruments with lock-in period) or make the withdrawal subject to market conditions at that time (e.g. equities/ mutual funds).
Ideally most of your emergency fund should be in bank deposits or liquid fund.
Numbers do not do justice to the returns on emergency fund, should need be. Hence it is an important element of your checklist before investing!
3. Get adequately insured
The checklist before investing is incomplete without the mention of insurance!
While investing and hoping to grow money is fine, but you also need to manage risk. More specifically financial risk that may arise due to unforeseen events. Insurance is tool to manage this financial risk. Most of this risk arise due to a major health issue or death, if you have dependents. Hence a health insurance and life insurance are important to begin with.
Also, lot of companies provide insurance cover for life as well as health. While this gives you a cover, I would suggest to get a cover from outside your employer too. This may be helpful if you move out of the organization to a place where insurance cover is not provided.
As your age increases, the premium you need to pay also increases. So suggest that you get an insurance early on, as you start working (I did this mistake of getting insurance a bit late!)
Also, getting insured is something I would suggest before investing. NOT alongside in same product. Avoid buying complex products that mix life insurance and investments. You are better off investing in both separately. (You can read more on term life insurance here)
Typically, when you start earning you can invest your investment journey. However, initial time period is often a trade off between getting these prerequisites in place and investing.
However these prerequisites do not end once you start investing. You need to keep on reviewing (and hopefully avoiding) debt, keep ensuring that you have an emergency fund and keep reviewing your insurance covers.
Any other thing one should ensure before investing?