For many people investing is the way to go to build wealth and hopefully financial freedom. But investing is not without risk. Over time, your investments will increase and decrease in value. Long-term however, a diversified portfolio tends to do fine.
But there are steps to take to make sure you are not forced to sell your investments at market lows. Let’s find out more about these steps!
1. Build an emergency fund
The first step is to build an emergency fund. You want to make sure that in case you lose your job, become sick, or if any other unexpected events occurs, you can hold on financially for at least 6 months.
As the name says, it’s a fund for an emergency. Not a fund to save up for a new car, a new house or any other material thing. It’s a fund to pay your rent, food, health care, insurance, etc. to survive until you have found another source of income.
2. Build a savings fund
The next step is to build a savings fund. The best thing is to save up enough to cover at least any foreseen expenses for the coming year. Expenses such as maintenance for your house, car and school tuition.
As soon as you have built up a savings fund to cover at least the expenses for the coming year, it’s best to go to step 3 and payoff any bad debt you may have. The returns on your savings account will never exceed the interest payments on for example your credit-card debt.
As soon as you have paid off your bad debt, you can either go to step 4 or build up your savings fund to a level you feel comfortable covering expenses and purchases for a longer period.
3. Payoff bad debt
Paying off bad debt is a quick-win to decrease your expenses and to free up monthly cash flow to save or invest. Examples of bad debt are credit-card debt, car loans or any personal loan used for buying stuff you don’t really need but bought anyway.
Interest rates of bad debt are often 10% or higher. If you don’t pay off that debt quickly it becomes a costly matter.
Last but not least, never take out bad debt to invest it in the stock market. It’s as risky as Russian roulette. As Warren Buffett said in his latest Annual Letter about using debt to increase investment returns: Usually win, occasionally die.
4. Learn about investing
Now that you have an emergency fund and a savings fund in place and paid off bad debt, you have got a solid foundation to explore the possibilities to put money in the stock market.
First it’s time to learn about investing. You need to understand what the risks and rewards are and whether you feel comfortable with these risks.
There are many books written about investing and writing all the details about investing is beyond the goal of this blog. But if investing is not obvious to you, please read my blog about active versus passive investing.
Last but not least, do not confuse investing with speculating! The stock market is not a casino you can enter and hope to get rich quick. That will not happen, at least not if you don’t want to risk losing your shirt along the way.
5. Write down your goals
If you fail to plan you are planning to fail. It’s true for many things and also for investing. You need to have a plan to stick to in times the stock market goes up and in times the stock market goes down.
If you know what you will do in either situation, you are one step ahead of many investors. Even the so-called experts on Wall Street are familiar with a widespread panic. Warren Buffett has said many times: Be fearful when others are greedy, greedy when others are fearful.
If you have a plan in place and considered the scenarios, it’s much easier to be greedy when investors in the stock market are fearful.
Write down your goals. How much money do you want to invest? How much money do you need to reach your goal? Do you feel comfortable to invest all your money in stocks? Or do you also want to include bonds and real estate in your portfolio?
Always prepare for the next recession. That’s when you can buy wonderful companies at bargain prices and possibly take a few shortcuts to reach financial freedom.
6. Invest periodically and consistently
Investing takes time. There is no easy way to build wealth. Investing takes consistent steps towards your goal by investing periodically over a long period.
Stay the course, invest your money in a diversified portfolio and minimize expenses and you will be fine over time. Investing is not rock-science, but it requires common sense, clear goals and a consistently applied approach. That’s how you build wealth.