When Should You Start Investing? 4 Signs You’re Ready
People invest to achieve financial goals and build wealth. But when is the best time to start investing?
In this chapter, we’ll take a look at:
It is a common recommendation that young people should start investing as soon as they can. However, before you start investing, you should ensure that a few essential requirements are fulfilled. Otherwise, you might reduce your chances of becoming a successful investor and achieving your financial goals.
In this chapter, we will discuss the best time to start investing your money and what you should do before you start.
🧭 Key Takeaways
- You should invest as soon as you have your finances in order and have leftover money with every paycheck.
- You should have a sufficient monthly income, no high-interest debt, and an emergency fund of at least 3 to 6 monthly salaries.
- If you are not yet financially fit, you can still invest in yourself by improving your skillset and learning new things.
When Is The Best Time To Start Investing?
The best time to start investing is now!
As a young investor, you might not have much money to invest yet. However, you have the most important factor of investing on your side: Time.
The longer you invest, the more you can benefit from the power of compounding. For every year you have your money invested, its value will grow exponentially. However, as compounding is an exponential process, it takes a lot of time and patience to start noticing the impact. Therefore, you must stay invested and keep contributing to your investments.
💡 Example
Imagine you make a $100 investment at a 10% annual growth rate. After the first year, your investment would have a value of $110. This includes your initial $100 investment plus $10 interest on your initial investment. In the second year, the value of your investment would rise to $121 as you would receive $11 interest on the previous value of $110. After 25 years, your $100 investment would have accumulated to a whopping $1,083. Therefore, young investors have a significant advantage compared to people who start investing later in their life.
Apart from the benefit of compounding, staying investing with a long time horizon also protects you from market fluctuations, market corrections, market crashes, and the loss of purchasing power through inflation.
While those market events temporarily cause a negative impact on your investments, they rarely last longer than a few years. As a result, if you start investing at a young age with a long time horizon, your investments will most likely not be negatively affected.
💡 Example
A excellent example of this has been the 2008 market crash. If you had sold your investments during the crash, you would have ended up with a pretty significant loss. However, if you had decided to stay invested instead, you would have more than outpaced the temporary losses by now.
And if you had followed a consistent investing schedule, you could have even bought many assets at lower prices and lowered your average purchasing price. As a result, you would have achieved an even more significant return.
To summarize, here are the benefits of starting to invest as early as possible:
- The value of your investments grows exponentially, thanks to the power of compounding.
- The longer you stay invested, the lower is the impact, and therefore investment risk, of short-term market fluctuations.
- Staying invested for as long as possible protects your money against a loss of purchasing power from inflation.
What Are 4 Signs That You Are Ready To Invest?
The general recommendation is to start investing as early as possible, but this advice might not apply to everyone right away.
Before you start investing, beginner investors should first check that they fulfill a few essential requirements:
- You should have a sufficient monthly income to make regular investment contributions.
- You should have no high-interest debt.
- You should have an emergency fund of at least 3-6 months’ worth of your current salary.
- You should make sure that you understand how the investments you plan to do work.
1. You Have A Sufficient Monthly Income
Having a sufficient monthly income is the first and probably most apparent roadblock to overcome before you’re ready to invest. But how much income is sufficient to start investing?
It highly depends on your individual circumstances, especially your monthly expenses and whether you have to support other people financially. However, in general, any income that covers your monthly costs and still leaves you some extra money at the end of the month is sufficient to start investing.
If you don’t have a sufficient monthly income yet, you should not start investing. Instead, focus on improving your overall financial fitness. There are two ways to achieve a higher household income.
First, you can either increase your monthly income by switching to a job with a higher salary, improve your qualifications and ask for a raise, or work on a side job. Second, you can look if there are possibilities to reduce your monthly expenses. For example, you could look into finding a cheaper apartment or reduce your monthly spending on subscription services.
2. You Have Paid Off Your High-Interest Debt
Once you ensured that you have a sufficient monthly income, you should look into paying off any significant debt you might have. Significant debts are debts with high interest rates, like credit card debt.
While compounding helps you grow your money and build your wealth, unfortunately, it also has the opposite effect on your debt. Like the returns on your investments, interest on your debt payments compounds.
As a result, you have to reach much higher investment returns to outpace the negative effect of the interest payments, in addition to the negative impact of inflation. Therefore you have to make riskier investments with a higher growth potential which can further negatively impact your investment performance.
Therefore, you should make sure to reduce your high-interest debt as soon as possible. While it may not feel like investing, decreasing your debt is a significant contribution to reaching your investment goals. It frees up your money to work for yourself rather than the debt issuer.
💡 Example
Imagine you have credit card debt with a high annual interest rate of 10%. At the same time, your investment portfolio only returns 8% annually. In this case, you would achieve a negative investment return as your capital gains are smaller than the credit card interest. As a result, it would be wise to pay off the credit card debt first before starting to invest.
However, it would be a different story when dealing with low-interest debt. For example, if you have debt with a 2% interest rate, you would still be able to make a positive investment return. Therefore, it might make sense to pay off your debt simultaneously and start investing money.
3. You Have An Emergency Fund
You should start saving for your emergency fund as soon as you have a sufficient monthly income and paid off high-interest debt. Your emergency fund is meant to help you in situations where you have to make more significant unexpected expenses that you would otherwise be unable to afford.
These unexpected expenses may include:
- Paying for repairs or replacements of broken devices, a broken car, your house, and other things.
- Paying for expenses when you are being unexpectedly laid off.
- Paying for expenses when you decide to quit your job and need time to find a new one.
Typically, it is recommended that you have at least 3 to 6 monthly salaries saved up in your emergency funds. However, you should save 6 to 12 monthly salaries if you work in an unstable job or are self-employed. This is because your risk of running out of money is higher in these situations, therefore you need a bigger financial cushion.
It is essential to maintain the value of the money you have saved in your emergency fund. You shouldn’t keep the money somewhere where there is a high risk of losing some or all of its value. In addition, you want to make sure that you can easily and quickly access the money if needed. Therefore, the best place to store your emergency funds is typically in a money market account or savings account.
4. You Understand The Basics Of Investing
You are almost ready to start investing once you ensured that your financial situation is in order. The final step is to ensure that you understand the basics of investing, including how investing works, what asset classes you want to invest in, and how much you can afford to invest.
However, one of the most important decisions young investors, like yourself, have to make is whether you want to follow an active or passive approach to investing. Active investors hand-pick their investments based on extensive fundamental research. On the other hand, passive investors rely on matching the performance of a subset of the market.
A passive investing approach is the better choice for most young beginner investors. You could, for example, invest in exchange-traded funds, which replicate the performance of a market index. This will guarantee you to achieve the average performance of the overall market without the need to put a lot of time into researching new investment opportunities.
What Should You Do If You Are Not Ready To Invest Yet?
Even if you might not be able yet to commit your money, you can still lay the foundations for building wealth and making your money work for you. As outlined above, you should first start improving your monthly income, reducing your expenses, and paying off high-interest debt.
However, there is another high-impact activity you can do: invest in yourself. For example, spend some time improving your existing skillset or learning new skills that might help you achieve a higher household income.
Warren Buffett once outlined why investing in yourself is so essential to becoming successful:
“Generally speaking, investing in yourself is the best thing you can do. Anything that improves your own talents; nobody can tax it or take it away from you. They can run up huge deficits and the dollar can become worth far less. You can have all kinds of things happen. But if you’ve got talent yourself, and you’ve maximized your talent, you’ve got a tremendous asset that can return ten-fold.”
In other words, no matter how good or bad your financial situation might be. You can always improve it by improving your skills and ensuring that you are the best version of yourself. If you can manage to achieve this, you will be able to start investing as soon as you’re ready.
Next Chapter
Continue with the next lesson of our beginner-friendly guide “Basics Of Investing”.