A 5-Point Checklist for How to Invest Money Wisely

Tempted to roll the dice with a windfall to make a quick profit? Use this five-point checklist to know if your financial foundation is strong enough to make a risky investment and why investing for the long-term is the best strategy.

Checklist for How to Invest Money Wisely

  1. Build an emergency fund. 
  2. Fill your insurance gaps. 
  3. Pay down dangerous debts. 
  4. Contribute consistently to a retirement account. 
  5. Fund your dreams.

You’ve probably heard about a day-trader or a lucky friend who bought a stock that was on a meteoric rise and then sold it to make a lot of money. Yes, it can happen. But the problem with short-term investing is that a stock that looks so promising can reverse direction in an instant, leaving you with a huge loss.

If professional money managers—who study company financials, stock movements, industry changes, and economic trends—can’t predict whether a stock will go up or down, don’t think you can “beat” the market with any certainty.

Betting on a stock’s price is no different than spinning the roulette wheel at a casino. Yes, it can be fun if it’s budgeted as entertainment and you can afford to lose.

But there’s a big difference between gambling and using a long-term investing strategy to build wealth. If you need money for everyday living expenses now or in retirement, I wouldn’t plunk it down at a casino or on an individual stock.

Review this five-point checklist to know if your financial foundation is strong enough to make a risky investment and how to create a more sustainable, long-term plan to build wealth.

1. Do you have an emergency fund?

Your number one financial priority before doing anything else, such as investing or paying down debt, should be to accumulate an emergency fund. Having a cash cushion to fall back on can be the difference between surviving a financial emergency—such as losing your job or having an unexpected medical bill—or getting buried under it.

According to a recent Unum study, nearly half (49%) of adults had less than $1,000 in savings. I don’t want you to be a part of that statistic.

Devastating events are tough enough to handle without also being stressed about money. When you don’t have a financial cushion to soften the blow of a large expense or a loss of income, you could end up going into debt.

Having at least a couple months’ worth of living expenses, and ideally a minimum of six, on hand gives you a tremendous amount of peace. You’ll know that you’ve got money to deal with just about any distressing situation that blows into your life.

Being financially responsible means that you’re prepared for a day when bad luck may strike.

If you don’t have a healthy emergency fund sitting safely in a bank savings account, use every bit of your extra money to build one. Don’t worry if your cash reserves earn little or no interest in the bank. They’re not supposed to.

While it might be tempting to invest your cash cushion, stick to a low-risk, FDIC-insured bank savings so you keep it safe from market volatility. The purpose of emergency savings is to be accessible and liquid in the short term. If you invested it, the value could shrink to nothing the moment you desperately need it.

Being financially responsible means that you’re prepared for a day when bad luck may strike. Think of an emergency fund as an investment in yourself that insures future financial safety and happiness.

Important Tip: If you’re struggling to build a cash reserve, automate the process by having a portion of your paycheck direct deposited into a savings account or transferring funds from your checking to savings.

2. Do you have insurance gaps?

In addition to using extra income to create a financial cushion in the bank, another critical way to protect yourself and those you love from something unexpected jeopardizing your financial security is having the right types of insurance. Without it, a catastrophic event—such as a health problem, natural disaster, or a death in your family—could wipe out everything you’ve worked so hard to earn, save, and purchase.

Drivers and homeowners with a mortgage must have auto and home insurance. But there are other types of voluntary insurance that can be affordable and give you financial protection.

Health insurance is the most important coverage to have because any kind of medical issue or accident could leave you with a massive bill. Even a quick trip to the emergency room or a short hospital stay could cost thousands of dollars. No matter the politics behind healthcare, going without a policy is a risk you should never take.

Disability insurance is another important, yet often-overlooked, coverage that every earner should have. It provides a percentage of replacement income if you’re unable to work due to a disability, illness, or accident.

Remember that health insurance only pays a portion of your medical bills; it doesn’t pay for living expenses, like housing or food, if you can’t earn money for an extended period. If you don’t have disability through work (or you do but it’s not sufficient), purchase a policy and have enough emergency money set aside to tide you over until coverage begins.

Life insurance is critical when your death would create a financial hardship for those you leave behind, such as a spouse or children. It can help put kids through college, pay off debt, or just provide daily living expenses.

There are different types of policies, but the most common and least expensive option is term life. It gives one or more of your beneficiaries a cash benefit if you die during a set period, such as 10 or 20 years.

The average annual cost for a renter’s policy is just $188 per year—that’s an insurance bargain no renter should go without.

Renters insurance isn’t a requirement, but it’s one of the best financial safety nets you can have. Not only does it cover your personal belongings up to certain limits anywhere in the world, but you also get liability coverage if someone gets hurt in your rental or you hurt someone off premises.

Important Tip: The average annual cost for a renter’s policy is just $188 per year—that’s an insurance bargain no renter should go without.

3. Do you have dangerous debts?

After you’ve got emergency savings and insurance to cover your back, it’s time to use extra money to pay down any dangerous debts. These might include expensive payday loans, credit cards, or car loans with an annual percentage rate of 10% or higher.

In general, it’s best to tackle your highest-rate debt first because it’s costing you the most in interest and gives you a higher return when compared to investing.

Leave low-rate debts, like mortgages and student loans, for last because they’re relatively inexpensive and come with a tax deduction on some or all the interest you pay, which makes them cost even less on an after-tax basis.

4. Do you contribute consistently to a retirement account?

After you’re prepared for the unexpected with savings and insurance, and cut any high-rate debt, your next financial to-do is to make consistent contributions to a tax-advantaged retirement account.

If you’re a regular Money Girl reader, you already know that contributing to a 401k, 403b, or 457 retirement plan at work is a good idea. They’re loaded with benefits including federal protection from creditors, tax-free contributions, tax-free investment growth, and free matching contributions from many employers.

For 2018, you can contribute up to $18,500, or $24,500 if you’re over age 50, to a traditional or Roth workplace retirement plan.

If you don’t have a workplace retirement account—or you do, but have maxed it out—invest through a traditional or Roth IRA when you have extra income. The money-saving tax benefits are comparable to a traditional or Roth retirement account at work, so they stretch your dollar.

For 2018, you can contribute up to $5,500, or $6,500 if you’re over age 50, to either a traditional IRA, a Roth IRA, or a combination of both types of accounts. However, unlike a Roth 401k, a Roth IRA has annual income limits which makes high-earners ineligible to make contributions.

For a summary of different retirement accounts, use the Retirement Account Comparison Chart as a handy reference tool.

Start investing in a retirement account as soon as possible and increase contributions every year until you’re setting aside a minimum of 10% to 15% of your gross income. Some investing firms allow you to automatically increase your saving rate 1% at the beginning of each year.

Let’s say you have a $50,000 salary and invest 10%, or about $400 a month, over four decades in a Roth IRA. Even earning a moderate 7% return on average, you’d have over $1 million to spend in retirement.

You can achieve impressive growth by investing in one or more diversified funds within your retirement account. A diversified fund can be made up of hundreds of underlying investments. It allows you to earn higher average returns while reducing risk, because it’s not likely that all your investments could drop in value at the exact same time.

Important Tip: If you have more than 10 years before retirement, choosing a stock fund is typically a good choice for an optimal return on your investment.

5. What dreams do you want to fund?

If you’ve got a handle on your emergency savings, insurance, dangerous debts, and retirement, it’s time to use extra income to fund your dreams. Maybe you’ve got your heart set on buying a home, traveling the world, starting a business, or going back to school.

How you should invest outside of a retirement account depends on when you plan to spend the money. Money for short-term goals should be handled differently than funds for long-term goals.

Expenses you plan to make in a few years, such as buying a car or taking a vacation, should be saved, not invested. You’re better off protecting this money from market volatility and potential loss by keeping it in a bank savings or a certificate of deposit, called a CD.

For dreams and financial goals that you want to achieve in five years or more, use a taxable brokerage or investing account. Brokerage accounts don’t come with any tax advantages, but unlike a retirement account, you can take withdrawals at any time without penalty.

Choosing diversified mix of investments, such as index funds, mutual funds, and exchange-traded funds, is a smart option compared to picking one stock to buy. Owning index funds is sometimes referred to as “passive” investing because they don’t attempt to beat the market, but simply mirror its growth. They give investors a cost-effective way to own many investments without having to do time-consuming research

The S&P 500 Index is a popular fund that owns small amounts of the 500 largest companies in the United States. When you own just one share, you become a part owner in all those companies.

While I don’t recommend trying to beat the market, if you or Marquis have everything in place that I’ve recommended:

  • accumulating a cash reserve
  • getting insured
  • eliminating dangerous debts
  • contributing consistently to a retirement account

…you could likely afford to swing for the fences by making a small, risky investment.

But first consider making a simulated or paper trade where you practice without risking real money. Keeping track of a hypothetical investment allows you to see if you would have made or lost money. Always be sure that your financial life won’t suffer if you make a risky investment that doesn’t work out the way you hope.

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