Before you start investing, you should cover the basics of your everyday finances. That means taking steps like building an emergency fund and paying off high-interest debt.
Many financial experts recommend that people maintain anywhere between three and six months’ expenses in an emergency fund (we recommend a Savings Builder account at CIT Bank). That means that if you spend $3,000 per month, you should have somewhere between $9,000 and $18,000 in savings. That’s usually enough to cover unexpected expenses or to weather a period of reduced income, such as unemployment.
The last thing that you want is to have to sell your investments when they’re low to cover living expenses, so a healthy emergency fund is important.
Getting rid of high-interest debt is also essential. For example, if you have debt that charges 12% interest, making extra payments toward that debt is equivalent to investing that money and earning a 12% annual return.
The S&P 500, an index of large American stocks, has provided an average return of 9.8% over the past century or so. Depending on your risk tolerance, you should aim to pay down any debt charging an interest rate near or higher than that. A common rule of thumb is to pay down debt charging more than roughly 6% interest before investing.
Of course, there are exceptions to this rule, such as investing enough to get your employer’s 401(k) match, but making sure you pay down costly debt and have emergency savings before you start investing are important.
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