For most people, investing is essential for growing their money and securing their financial future. It's the greatest path to building wealth over time. That said, investing isn't always right for everyone at all times. If you're wondering if investing is right for you, here are three things you should make sure of.
1. You have an emergency fund saved up
Investing is great for your financial future, but you shouldn't do it before you have an emergency fund saved up -- one of the most important things in your financial life. Whether it's a car repair, house repair, medical emergency, or job loss, a major unexpected life expense can, and will, occur.
Without an emergency fund, you run the risk of having to take out a loan to cover the expense, which adds to the cost because of the interest you'll owe. And if you're forced to rely on a non-traditional financial institution like a payday loan service, the interest rate could be well into the double-digit percentages. If you've been investing without an emergency fund and an unexpected expense happens, you could be forced to sell shares, possibly resulting in owing taxes on any profits (or taking a loss).
The general rule is to have three to six months' worth of expenses saved. If you're only responsible for yourself, you could feel comfortable with three months. You should aim for the higher range if you have a family and children. Given the increased economic uncertainty right now, it may be better to aim for six months to a year's worth of expenses saved.
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2. You know what type of investing you're interested in
There's no one-strategy-fits-all when it comes to investing. Different people have different personal situations that inevitably affect what type of investing they want to do. There are three broad types of investors: value, growth, and income investors. Value investors focus on finding stocks trading below their intrinsic value. For example, Shopify is currently priced at around $40 per share, but if an investor believes its value is $50, they might consider it a good investing opportunity.
Growth investors look for younger companies that have the potential to grow at rates well above industry averages. This is generally where most tech stocks fall whenever they become public companies.
Income investors focus on companies that consistently pay out sizable dividends. Dividends are paid quarterly from a company's profits and can provide great supplemental income. Older, more established companies tend to pay dividends to make up for the lack of hypergrowth potential.
You don't have to focus on one specific type of investing; many investors look for undervalued companies, take chances on growth stocks, and accumulate dividend-paying stocks simultaneously. But when you're just starting to invest, it helps to focus on one style so you don't spread yourself too thin while still learning what works for you.
3. You know your risk tolerance
In investing, your risk tolerance is how much volatility you can stomach and how much you're willing to lose as an investor. In most cases, the trade-off is higher risks for the potential of higher returns. That's why bonds typically offer very low interest rates compared to what you could potentially make by investing in the stock market. For some people, their main goal is to make as much money as possible; for others, it's to make a moderate amount of money while minimizing the risk involved.
Many things influence a person's risk tolerance: personality, family status, age, wealth, and much more. There's no right or wrong risk tolerance; it's all about doing what's comfortable for you. Knowing your risk tolerance is important because that will guide the type of stocks you invest in.
For example, if you're risk-averse, you probably wouldn't focus on small-cap growth stocks because they're more prone to volatility and influenced by broader economic conditions. If you're risk-tolerant, you may be comfortable taking on the risk that comes with small-cap stocks because of the higher upside they tend to have.
Knowing your risk tolerance is one of the most important things you can do before putting your money on the line by investing.
