Moving from saver to investor is a big step. Even though you’ve selected the brokerage company that works best for you and your situation, there are still some other considerations.
It’s crucial to only invest money you won’t need in the immediate future. Investments fluctuate in value, so you don’t want to find yourself forced to sell at a time when the value of your investments has temporarily declined. To determine whether you have enough money to begin investing, follow these steps:
Review your savings goals and habits
Consider investing only if you have already established an emergency fund and have achieved your other major savings goals, such as saving for a first home. Most people don’t start investing substantial amounts of money until they own their own home. One exception to this is retirement investing: smart people start investing for retirement as soon as they start working – usually through IRAs or workplace sponsored retirement accounts, such as 401(k)s or employee stock purchase plans.
Consult your budget
In general, you should begin investing only if you have a budget surplus of at least $300 – 500 each month after covering all your expenses, including amounts that you’ve reserved for specific savings goals. If you have no surplus, or a surplus of less than $300, you shouldn’t be investing at this time.
Save for an initial deposit:
Most investment accounts require an initial deposit of $1,000 or so, though some like Scottrade do require less. If you don’t have that much cash on hand, you’ll need to create a savings plan to help you reach that goal first.
Set up an automatic investment plan:
Once you’ve begun investing, generally it’s best to invest your entire surplus each month. Most banks and investment firms offer automatic investment plans in which you can have a set amount of money transferred directly into your investment account at set intervals, such as with every paycheck or at the end or beginning of each month.
Why Invest Anyway?
Investing is the most effective way to build your wealth at rates that exceed those of inflation (an economic phenomenon that causes the prices of goods and services to rise over time). Inflation doesn’t change the amount of money you have, but it does erode your purchasing power – the amount of goods and services that you can buy with your money. In short, inflation explains why homes that cost $25,000 during the 1960s costs more than $700,000 now.
Since 1925 (oddly enough the same time the Federal Reserve started messing around with the money supply in the US), inflation in the United States has averaged 3% per year while the average savings account has paid an interest rate of about 2% or less. During the same period of time, the return, or the annual rate of growth, of U.S. stocks has averaged 10%. Subtract inflation and you lose money with the savings account and net 7% through investing.
- If you keep your money in a savings account: It won’t grow at rates that keep pace with inflation, and you’ll end up losing purchasing power each year. A savings account is a holding account whereas investing is a growth account (hopefully).
- If you invest your money instead: It can grow at rates that do beat those of inflation, which can enable you to increase your purchasing power over time.
One of the best books on investing I’ve ever read is How A Second Grader Beats Wall Street by Alan Roth. When you’re ready to start investing, make certain you read this book.
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