You have a few bucks set aside, you've just canceled your subscription to WiseMoney, you've stopped watching the "Cable News Wisdom Channel," and you're thinking of starting to get a little bit Foolish with your dough. In fact, you've even peeked ahead a few steps to read about choosing a broker to make your first purchase of stock ...
Hey! Whoa there!
Not so fast, buddy! What's your rush? We know you're on the information superhighway and all, but believe us, when it comes to investing money you've worked hard to earn, you want to obey all the speed limits. Your personal finances need to be in squeaky-clean order before you ever think of placing that exciting first stock trade. Fools will you implore you again and again: Do not ever rush. This second step is here to tell you to settle your personal finances.
Erase credit card debt
First stop ... how thick is your billfold these days? Is it full of cash or credit cards? One of the critical keys to investing is to use only money that is free of other obligations. Thus, if you are carrying a revolving balance on your credit cards, it ain't free! (Neither are you, unfortunately.) Here's why: Many credit cards have an annual interest rate of 15% or more.
Let's say you have $5,000 to invest but you also have $5,000 in credit card debt with an average annual interest rate of 18%. If you invest the $5,000 rather than use it to pay off the credit card, you will have to get an 18% return on your investment after taxes -- or around 20%-25% before taxes -- just to break even.
Credit card debt remains the single best answer we know to the question "Why can't I ever seem to get ahead?" As of this writing, more than a billion credit cards are in circulation in the United States -- that's more than three cards for every American man, woman, and child. And nearly 70% of all credit card holders in the U.S. today carry a revolving card balance every month and are paying just the minimum amount due.
On a card with an annual interest rate of 18%, making minimum payments (2% of the balance or $10, whichever is greater) on just a $1,000 balance is going to take you a little more than 19 years to pay off. During that time, you will pay close to $1,900 in interest on that $1,000! It's enough to make you want to get into the credit card issuing business, isn't it? When you're ready, you can think about investing in a company that does.
As you now chart your path to becoming a more Foolish investor, we simply will not let you pass on to Step 3 until you stop letting the credit card companies feed on you. Find out the details on how to pay down your debt, or discuss your credit card questions with other Fools. Whatever it takes, pay off that plastic.
A plan for regular saving
Next stop ... how well are you regularly paying yourself? In other words, are you routinely setting aside an adequate established percentage of your paycheck every payday? Or do you set aside money only when there's something left over? Or worse, are you finding there's nothing left to pay yourself with?
If you answered yes to either of the last two questions, you're simply not ready to pass "Go" yet. It's time to examine why you aren't paying -- or can't pay -- yourself. A Fool does not go investing with his or her lunch money, or next month's rent, or with money that should go toward paying off a credit card. Invest only money that is free of other obligations.
Fools try to save around 10% of their annual incomes. For some, it'll be closer to 5%. Others, like professional athletes whose paychecks are delivered in tractor-trailers, might manage to put away 15%. The important thing is to live below your means and establish a regular rhythm of savings.
A plan for life's hiccups
We'd be remiss if we glossed over the importance of having an emergency stash of cash at the ready for life's inevitable bumps. The law of life dictates that when the water heater goes "BLAM," the chances that your teenager will accidentally drive into the garage door quadruple. A cushion of short-term savings -- three or six months' worth of living expenses -- can keep you from having to rely on high-interest plastic, or, worse, from ending up in bankruptcy court.
We've devoted an entire area on our site to helping you figure out how much of a cash cushion you need and the most suitable place to keep it. (Hint: It's not in your mattress.) We treat short-term savings -- your emergency fund and any money that you might need to get your hands on in the next five years or sooner -- very differently from long-term investments.
When your cash cushion is funded, it's time to move on to your long-term savings. If you already are routinely saving, are you exploiting all of the possibilities you have to make that money grow tax-deferred -- such as through an IRA, or an SEP, or a Keogh, or a 401(k), or a 403(b)? Money in tax-deferred retirement plans can grow exponentially compared to money in a regular investment account, because you don't pay taxes on the money deposited or the earnings until you begin to withdraw it.
Further, a number of employers now offer to match your 401(k) plan savings with additional monies kicked in to benefit you. That's free money! Make certain that you're plowing as much of your savings as possible into these highly Foolish vehicles. Remember: Pay yourself first, and you'll thank yourself later.
Learn more about the rest of your personal finances
Before you leap headlong into that dramatic first investment, you should at least give some additional thought to other aspects of your financial life, such as buying a home, building an emergency fund, or handling your taxes. We cover it all in our Personal Finance area.
Get help sorting it all out
Life has this way of squeezing important, big-dollar decisions into small time frames -- from getting off to a solid start early in your investing career to handling complex financial messes at critical moments. In times like these, it may be best to call in an honest and good financial pro.
"What?" you say. "Isn't that counter to what Foolishness stands for?"
We Fools have always maintained that you are the very best person to manage your money. Like any successful executive, though, there are times when you must seek out the best help you can get. A good financial pro may earn his or her fee many times over by helping you through a number of sticky situations:
- The death of a parent.
- Marriage.
- Divorce.
- Complex financial products.
- Buying and selling a house.
- Saving for college.
- Estate planning.
- Retirement.
- Handling employee stock options.
It all boils down to this: When it comes to your money, get all the help you need from whatever source works best for you. Of course, it's important to know your team members and their allegiances and to weigh all advice accordingly. So we encourage you to become an educated consumer.
With that thought fresh in our minds, let's move along and make you a Foolishly educated consumer.
To see the rest of the 13 Steps, follow the links at the bottom of this article.
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