When it comes to investing, you may very well turn out to be the next Warren Buffett. Even if you've got what it takes to succeed as Mr. Market's master, however, there is one absolutely critical step you need to take first. Before you stick one thin dime in the market, you must have the rest of your financial house in order.
No investor can be successful if forced by circumstances to pull money out of the market at an inopportune time. But if you don't take care of your personal finances first, that is exactly the risk you take every time you invest.
Why it matters
After all, even Buffett has a less-than-perfect track record. On the buy side, timing his purchase of ConocoPhillips (NYSE: COP ) right when energy was peaking caused him to take a huge paper loss. On the sell side, he missed his chance to sell Coca-Cola (NYSE: KO ) at significantly richer levels a decade ago. And from the perspective of a completely missed opportunity, he passed on buying Wal-Mart (NYSE: WMT ) before it became huge.
If even Buffett can see an investment tank shortly after he buys it, what makes you think it won't happen to you? Oh sure, if your investing thesis is correct, under most circumstances, you can wait out the market's meandering and see a positive return. But what if you need money right away and the only source of cash you can tap is locked up in some tanking stocks? You could be forced to sell low, even if your investment would have eventually turned out fabulously.
Surprises need not be disasters
Of course, not every unexpected expense is because of a disaster. Early last month, for instance, my wife and I were blessed with our third child. As thrilled as we are to welcome him into our life, there is one logistical problem: Three car seats simply did not fit in the back of either of our sedans. As a result, we needed a larger vehicle to carry our family. While we had nine months to prepare for that particular expense, minivans don't exactly come cheap.
On top of that, our 20-year-old furnace gave up the ghost just as this year's heating season got underway, leading to another surprise expense. All told, between the minivan and the replacement furnace, we've spent around $35,000 this year that we certainly didn't expect to be spending when we rang in New Year's Day.
Preparedness pays
With the gyrations in the market this year, we very likely would have been forced to sell our stocks at an inopportune time to cover those unexpected expenses. What protected us from forced liquidation were the efforts we took to put the rest of our financial life in order:
- When we finished paying off my wife's car a few years back, we kept "making the payments" -- we just deposited the monthly amount into a savings account earmarked for a new vehicle, rather than writing a check to the finance company.
- Since paying off that car, we've limited our debt to just our fixed-rate mortgage.
- We had built up an emergency fund capable of covering a few months of living expenses.
All of those factors working together enabled us to scrape together the money to handle this year's financial surprises. Granted, we've exhausted most of the savings buffer we once had. But fortunately, our current challenge of rebuilding that savings is easier than the burden we would have faced if we had been forced to borrow to cover those surprises.
How will you get yourself ready?
If you want to be prepared for the curves life throws your way, the easiest way to build up savings is to make it an automatic part of your monthly routine, as if it were any other bill. Either through payroll deduction or a scheduled transfer at your bank, by paying yourself first, you're putting the toughest part of the process on automatic pilot. Once you've adjusted to the change in take-home pay, you'll never miss the money. But you'll sure be glad it's there when you need it.
Unfortunately, as this table shows, interest rates on savings accounts are anemic these days:
|
Company
|
APY
|
Minimum Balance to Earn Rate
|
|
Discover (NYSE: DFS ) Bank
|
1.85%
|
$1
|
|
MetLife (NYSE: MET ) Bank
|
1.50%
|
$25,000
|
|
HSBC (NYSE: HBC )
|
1.35%
|
$1
|
|
Univest (Nasdaq: UVSP )
|
1.25%
|
$1
|
Source: Bank websites, as of Nov. 1.
That said, it's certainly better to earn any interest than to either pay exorbitant rates or be forced to liquidate your investments at a substantial loss to cover unexpected expenses. So before you invest a dime, make sure you have the rest of your financial life in order. As boring as that may seem, when you need the money, you'll be glad you did.
How do you make sure you're saving enough? Let us know in the comments box below.
RSS Headlines
Fool UK