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Step 3: Treat Every Dollar as an Investment
Most of us have heard the old adage, "Pay yourself first." It has been trotted out so often that it's part of the financial canon -- the de facto Rule No. 1 for managing your money.
It's certainly sound advice, but frankly, it leaves us Fools hanging: How much? How often? Where to put it? What's next?
Don't pay yourself just yet
As far as financial rules of thumb go, we think we've come up with a better one. Just in case you overlooked the big, bold headline, we prefer this mantra: Treat every dollar as an investment.
That's the very foundation of successful investing. We like it because it offers a clear guideline for every financial decision you encounter. (Plus, "Don't buy stuff you cannot afford" was already taken.)
Make one great investment every day
To us, an investment is more than something you make in your brokerage account. An investment is anything that affects the quality of your life. Once the basics are covered -- food, shelter, workplace-appropriate attire -- every dollar equals opportunity. And every day presents new opportunities to make your money work harder for you, whether for long-term gain (retirement savings), short-term safety (emergency fund), or immediate pleasure (mocha latte -- hey, we're not here to judge).
After a while "treat every dollar as an investment" becomes second nature. It seeps into your subconscious like a catchy song you just can't shake. Soon you'll be looking for "investment" opportunities in every nook and cranny.
But before you set up your brokerage account and dive in, make sure you're not overlooking a few essential first investments.
Investment No. 1: Pay off The Man. In almost every scenario, there is no better use for your first freed-up dollars than paying off high-priced debt, which, for most, means revolving credit card debt. We'll prove it.
Consider the difference between setting aside $200 a month and coming up $200 short and covering it with a credit card. After five years of that -- assuming you simply stuff your $10s and $20s into a coffee can, your credit card charges 18% interest, and you pay a minimum $15 a month toward the balance -- here's where you’d be:
|
Years |
$200 in Monthly Savings Amounts to … |
Putting $200 per Month on a Credit Card Amounts to … |
|---|---|---|
|
1 |
$2,400 |
($2,652) |
|
2 |
$4,800 |
($5,583) |
|
3 |
$7,200 |
($9,088) |
|
4 |
$9,600 |
($13,278) |
|
5 |
$12,000 |
($18,288) |
As you can see, "Pay yourself first" points you in exactly the wrong direction in this scenario. Stashing your cash in a savings account earning nearly 20 times less in interest than you're paying on those lingering credit card balances leaves you $6,288 in the hole after five years, and you’ve paid nearly $7,000 in cumulative interest charges alone.
The bottom line: If you have credit card debt, invest in its destruction. Use the "Should I pay off debt or invest in savings?" calculator to see how much money you can save by making the investment to pay off the plastic.
Then, head to Fool.com's credit and debt area where you'll find a handy "60-Second Guide to Getting Out of Debt" and a step-by-step action plan in the "How-To Guide: Reduce Your Debt." Best of all, you've got a built-in support network ready to answer questions, offer tips, commiserate, and cheer you on at the robust Credit Cards and Consumer Debt discussion board.
Investment No. 2: Amass a cash cushion. Stuff happens -- stuff that requires money to fix, such as a job loss, car transmission issues, and a really bad haircut before your high-school reunion. If you don't have the money on hand, you'll have to make a crash financial landing, which could mean patching over the problem with a credit card.
Your emergency fund needs to be readily accessible in a simple savings account. Don't expect to make a killing on this investment. The interest you can get on most savings accounts won't even keep up with inflation.
How big should this essential investment be? Here are some basic guidelines:
|
If you … |
Then your emergency fund should cover living expenses for … |
|---|---|
|
Have no dependents relying on your income |
3 to 6 months |
|
Are the sole breadwinner or work in an unstable industry |
6 to 12 months |
|
Are retired and living on a fixed income |
5 years |
Sweat the big stuff and the 80/20 rule
One other thing we want to make clear: Not every "investment" has a dollars-and-cents return. Or, in more practical terms: Go ahead and enjoy your daily latte. At The Motley Fool, we're hardly advocates of excruciating denial and extreme penny-pinching in the name of "investing."
We'd much rather you spend your energy on the big stuff that really pays off -- the 20% of line items on your budget that counts for 80% or more of your spending -- things like your mortgage, cars, travel, insurance, and any four-figure line items in your budget.
Free online budgeting tools like Mint.com (a Motley Fool partner) and QuickenOnline.com give you an instant snapshot of your spending and saving. Pinpoint your 20%, and earmark a few hours to cut those costs. Then take that savings and put it to work in bona-fide investments -- in the traditional sense, that is.
Not coincidentally, making those first stock market investments is the topic of the next step. And for many of you, we're about to unearth an investment that is guaranteed to double a portion of your money. Really!
Action: Spend less -- instantly. Someone somewhere has probably given you the advice to track your spending for a month to see where your money goes. We prefer instant gratification. Instead of recording your every purchase for 31 days, just do it for three days. In fact, you don't even need to track it -- just consciously ask yourself every time you whip out your wallet, "Is this the best investment I can make with this dollar bill?" For a helpful reminder, sheath your credit and debit cards in our "Spend Less Patch." We guarantee you'll start making smarter money choices.
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Report this Comment On September 07, 2010, at 2:50 PM, ServusDei7 wrote:
Credit cards balances should always be paid off entirely every month. However, if you have student loans or other loans that charge less than 5% interest, it would make sense to delay paying off the loans and use the money to invest in stocks instead, if valuation of stocks are low enough (P/E below 8 is safe enough). If stocks make 10% a year, and your loans only cost 3% a year, you make 7% a year by borrowing. However, if valuation of stocks are high (P/E > 20), I would pay off ALL loans first, because the market will probably head lower to give you a better buying opportunity.
Report this Comment On October 07, 2010, at 9:45 PM, StraitBiznes wrote:
My mother is in tremendous credit card debt right now, and she is slowly digging her way out of it. I have learned a lesson about high interest debt by watching her and living through some of the aftermath.
I am going to go through these 13 steps relatively slowly in order to ingrain the information. I think investing is more like a marathon than a race, like most things in life.
Report this Comment On December 24, 2010, at 4:30 PM, jasontylers wrote:
I've recently found myself in the situation with student loan debt. I don't accumulate credit debt and have my first job out of college. What brought me to this site was the seemingly incredible amount of knowledge on investments. My search for information lies mostly in my need to learn more about the stock market and investing in general.
I'm learning all I can from the site but the help from the users is great! Anyone willing to help point me in the right direction is much appreciated.
Love the site so far!
Report this Comment On January 13, 2011, at 9:23 AM, fysfil wrote:
I have a question about the time that is recommended for emergency funds for a retiree: five years. I would like to know the origin of that time, please....and can some of that money be available in the form of "unused" home equity loan?
Report this Comment On February 16, 2011, at 10:45 PM, AT4stockguru wrote:
Simple rule for any loan for that matter..use it if the rate of interest is VERY LESS thats less than 2-3%
this allows you with funding your needs like House, Car, Stocks, travel etc. I think getting funds/loan is always good but piling it up out of ignorance is dangerous
Report this Comment On February 18, 2011, at 3:05 PM, mountain8 wrote:
AT4 - Sorry but your comment went right over my head. I am a writer but I can't seem to gather your meaning. Could you review and expand please.
Report this Comment On June 02, 2011, at 7:18 PM, pypsa wrote:
would like to know what is shorting a stock
and what is limit
Report this Comment On January 13, 2012, at 7:18 PM, bigjay455 wrote:
ill stay with old cars
Report this Comment On March 27, 2012, at 12:28 AM, weirdcity wrote:
I don't get the 20/80 rule... can someone explain it to me like I'm a five year old.
Report this Comment On May 15, 2012, at 2:22 PM, ButtahNBred wrote:
"(P/E below 8 is safe enough)"
Can someone explain what P/E stands for and why below 8 (I'm guessing percent) is safe?
Report this Comment On August 18, 2012, at 11:14 AM, iseeksafestocks wrote:
i will never own a credit card
Report this Comment On September 07, 2012, at 12:41 PM, beth1992 wrote:
Ditto on the question about the need for five yrs worth of emergency funds. Can't see myself ever doing that. Way too much waste of useful funds. Where did that number come from? Is it assuming no income from pension/ social security/ dividends?
Report this Comment On November 27, 2012, at 3:31 PM, iseeksafestocks wrote:
Say you have $100,000 and let's say you pick a stock like Walmart and you only invest $10,000 when it drops 3% and than hold it Until it turns a 0.20% profit that is $20.00 for virtually no risk Walmart almost never goes down and stays down look it up.
Report this Comment On January 13, 2013, at 10:25 PM, Katbaloo wrote:
I too am going to take this info in slowly. I need to make up for lost time.
On credit cards..... I accidentally learned the formula for never having to pay interest. It's a game!
Thank goodness for my last layoff in the 90's with a year to prepare for it. (paid off most debt and headed back to school). By the time I was laid off my credit score was sky high (sacrificed for a year) & the low to zero interest rate offers were rolling in even though I was jobless! I still use a credit card for emergencies and pay them off as soon as possible but .... I never have to pay interest..... It's a game and it's staring you right in the face.
Report this Comment On March 03, 2013, at 5:54 AM, mjspina wrote:
I can understand the point about paying debt before saving, since debt is usually always at a higher percentage, but there is a fundamental problem with this ideology. Most people are never free from debt. Lets say you go to college. That racks up money you'll be paying back for a while. Then, you're going to want to buy a car. Keep in mind, before you buy a car with credit, you're going to need to use a credit card, then maybe a personal loan or two in order to build up your credit before qualifying for a sound auto loan. A little later in life, you're going to want to finance a house, hopefully not while you're still paying off college and that car you bought. You'll get married, have a kid, and now your bills are higher while still paying off the aforementioned. My point is, if you're ONLY putting your money to bills and not to your life, you're going to be waiting forever to put cash in your bank. You need to treat your investments like bills as well. Credit = Time to pay money. Use the time you've been allotted wisely.
Report this Comment On May 26, 2013, at 7:25 AM, The1MAGE wrote:
mjspina, it is true that most people will not be free of debt, and that is not a problem with the pay debt first ideology, but with the people not paying it off.
As a result of our really bad financial education, people believe that debt is a good thing, and having a credit card with a massive balance means you have made it.
I spent a few years paying down our debt right before the 2008 crash. As a result my hours went down, and so did my pay. I was making about half what I was before. But that was right when paying off our debt was really kicking in. Even with our "financial trouble" we were still paying off debt like crazy, and our bank account kept growing. (I need to point out our income was below average for a couple before the hit, so we were not doing this with doctor incomes.)
I almost felt guilty that I kept hearing how many people were struggling while we were doing better then ever. And our debts kept getting paid off.
We did focus on living below our means, and bought cheap cars for cash. We also pretended we still had a car payment, and stocked away funds that paid for our trade ups. (It's surprising how quickly that builds up when your not paying interest.) I should mention I do not buy new cars. I would rather let somebody else take the depreciation hit. I guarantee any extra maintenance is a lot cheaper.
One thing they didn't take into account in this article is that the return on paying down debt is tax free. Maybe you can defer your taxes, but eventually you will have to pay them. I know with an additional part time job, I would have to make over $750 a month to make $500 after tax.
So every dollar in reduced payments is like $1.50 in taxable income.
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