Before You Invest

Last week we got a general understanding as to whether the Drip strategy would fit one's portfolio. Now it is time to take the next step.

We have heard about debt in other articles, and certainly this is a subject that needs to be addressed before one begins to invest. However, I do not believe that one should necessarily wait until all debt is gone before starting the process; it depends on the kind of debt. Very generally, there are two kinds of debt: good debt and bad debt.

Bad debt is most commonly, though not exclusively, accumulated through the use of credit cards. The card can give a false sense of affordability, when making the purchase may not be a financially sound decision. The come-on of a minimum payment is an expensive proposition indeed, and prospective Drippers should remove themselves from this loop of payments before beginning to invest.

The crux of bad debt is that it is unnecessary for one's future prosperity. In diametric opposition is good debt, which is incurred to an advantageous end. Examples of this would be a mortgage, a car loan, or a college loan. The average person doesn't have enough cash to purchase a home, car, or college degree; assuming debt to acquire shelter, equity, transportation, or a better career is a necessary -- and usually good -- investment.

(For information and folly on these major purchases, see the Fool's comprehensive Personal Finance area.)

Good debt is a temporary step back that allows one to move ahead with greater strength. Bad debt is often a long-term drain on resources. Obviously, being debt-free is the best scenario, but understand that good debt is an investment, just as is the Drip.

Another part of the pre-Drip process is establishing a budget. Every investor needs to understand how the income of their monies relates to its outflow. This is probably the easiest step.

Some expenses will occur on a regular basis, like the mortgage or rent, so they are easily predictable. Although others will vary, like the electric or telephone bill, the average monthly cost can be estimated. Once the necessities are established and subtracted from the monthly income, the remainder is theoretically available to invest. Select an amount that you feel confident you will be able to invest every month and assume that it is no longer available. You won't miss what you don't have.

If you have additional, irregular sources of income, determine a percentage to be invested. For instance, occasionally I will sell a photographic print through my website or the gallery where I show my work. Half of this money gets invested, a quarter gets set aside for taxes, and the final quarter I spend.

Finally, make sure that you are contributing the maximum matched amount of your employer's retirement plan. I am fortunate that my employer matches up to 7.5% of my income in a 403(b) plan. This being the case, I assign a full 7.5% of my paycheck to this offer of "free money." Ensuring that you take advantage of these opportunities should be an integral part of your investment scheme.

This done, we can start picking companies, right? Well, no, but we're getting close. We still need to determine how many companies we should hold in our portfolio. After all, it makes little sense to start with a dozen Drips, only to later realize that we should be holding half as many.

As the number of companies to hold will vary with each individual, next week we will go over some guidelines on how to determine the right portfolio size for you. To discuss this column, please visit us on the Drip Basics board linked below.

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