While you should start investing as soon as possible, there are a few prerequisites you should make sure you have in place before you start.
Emergency Fund
You should first save enough money to have an emergency fund. Also called a cash buffer, or safety net.
It should cover at least one month of living expenses, to guarantee that you can pay off all your monthly bills and expenses without worry.
Ideally, you should aim to have about 3-6 months of living expenses saved up.
If you are fortunate enough to have your parents supporting you, this step may not be as necessary, because your parents will pay for most of your living expenses.
Having an emergency fund is very, very important.
Every investor will go through a recession. If there is a significant market downturn, where your investment portfolio declines in value by anywhere from 20-50%.
If you simultaneously lose your income temporarily, you want to be able to pay your living expenses without having to sell your investments.
The absolute worst case scenario is being forced to sell your investments just after a market crash.
This is because you are selling at a low price and lose a lot of money. But also, the years following a market crash when the market recovers often involve the biggest investment gains.
If you sell, you also miss out on these significant returns.
Invest Only What You Don’t Need in the Short-Term
Like previously mentioned, investing in the stock market has risk, that includes the possibility of large short-term drops.
To avoid being forced to sell your investments during these dips, ensure that you only invest money you don’t need for at least the next 3-5 years.
This is separate from your emergency fund.
This is intended for bigger purchases, such as a home purchase, education expenses, or starting a business.
If you invest money that you plan to use, there is some probability that there will be a market drop, and you two 2 choices:
- Sell at a low price and lose money.
- Choose to delay your large purchase.
Both of these aren’t ideal.
Pay Off Any Debt With a High Interest Rate
Before investing, it’s essential to pay off any high-interest debt, such as credit card debt.
High-interest debt can quickly snowball and quickly become unmanageable.
If you’re paying 20% on your credit card but earning only 8% on your investments, this is not a good trade-off.
In general, in personal finance, it is a terrible idea to carry any high-interest debt, whether you are investing or not.