Over the long haul, investing in stocks has been the best way to preserve wealth and earn strong returns. Though the market turbulence has given investors an unusual opportunity to buy stocks at low prices, there are several reasons why you shouldn't put more money into the stock market until the rest of your financial situation is stable.
The big picture
Personal finance is about much more than just investing. After all, investing is just one step in a long chain of things you have to do to put together a viable financial plan. For instance, without taking control of your spending, you probably won't have any money to invest in the first place. And at the other end of the spectrum, even if you successfully invest your money for decades, it won't do you any good if you squander it on things you don't need and can't afford.
With this big picture in mind, here are a few things you should take care of before you start adding to your investments.
Dealing with debt
Many financial problems that families face today come from badly managed debt. Some credit card rates have started to fall, but several card issuers, including American Express (NYSE: AXP) and JPMorgan Chase (NYSE: JPM), have bucked the trend in recent months.
Yet unless you have a remarkably low rate, it usually makes more sense to pay down a card balance than to invest. Consider: If your card charges 15% interest, paying it down is like getting a 15% return on an investment. If you put that money into stocks instead, you'd have to earn even more than 15% -- because in most cases, you'll have to pay taxes on capital gains and dividends.
An umbrella for April showers
Even if you have your debt paid off, unexpected problems can jeopardize your finances. With the economy on shaky ground, having an emergency fund to cover several months of living expenses if you lose your job can make a big difference.
Unfortunately, high-yield savings accounts at online banks like E-Trade's (Nasdaq: ETFC) banking division or ING Direct (NYSE: ING) don't pay the rates they used to. Nevertheless, they're still a good way to stay smart with your cash.
Big-ticket items on the horizon
As recent market drops have shown, the stock market is no place to put money you'll need shortly. So if you're saving money for a large purchase, such as a car or a down payment on a home, keep it safe and stay out of stocks.
In particular, the credit crunch has led many lenders to require higher down payments for mortgage loans. For instance, Wells Fargo (NYSE: WFC) now requires 25% down payments in some hard-hit areas. That means you'll need to have even more cash on hand before you buy a new home. It may be tempting to invest in stocks and hope big returns will make saving for your down payment a little easier. But you could easily see further losses in the short term -- putting your dreams on hold even longer.
Your time will come
If you have all your other bases covered, then now's a great time to invest. But with a recession, you want to make sure you've protected yourself from other economic problems before you commit precious cash to the ups and downs of stocks.
To learn more about getting your financial ducks in a row, read about
- Why the market isn't your biggest financial problem.
- Who'll be the recession's next casualty.
- What you can do to survive the recession.
