Investing For Your Future Monthly Message
Barbara O’Neill, Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension
Investment Pre-Requisites: Emergency Funds, Adequate Insurance, Low Debt, and Financial Goals
One of the most important pre-requisites that people should have in place before investing is savings that can be tapped in the event of an emergency. An emergency cash reserve is extremely important for sound financial management. Setting aside money to meet unexpected expenses provides a financial safety net and provides ready cash to both pay for unexpected expenses and to take advantage of financial opportunities as they arise. Emergency savings reduces the risk of having to sell an investment at an inopportune time or add debt to a credit card to generate cash quickly.
Most experts recommend an emergency fund equal to at least three to six months living expenses. However, it may not be necessary to set aside all of this money in a low-yielding passbook account, certificate of deposit, or money market mutual fund or money market deposit account. Some of it could come from a low-interest home equity line of credit (HELOC). The exact amount of a family’s emergency fund depends upon factors such as age, health, job outlook, and personal financial situation (e.g. amount and kind of insurance coverage). For example, you should have enough money in an emergency fund to pay the required deductibles on property and health insurance claims.
Consider a larger emergency fund if you are in business for yourself, your work is seasonal, or you rely heavily on commissions for income. You have a greater need for emergency cash than people with a regular paycheck. If your health is questionable and you foresee long-term disability or extensive medical expenses, you anticipate a large expenditure for the care of a relative in the near future, or your child is about to enter college, you may also need a larger cash reserve.
An emergency cash reserve can be subdivided in such a way as to minimize penalties for early withdrawal of large amounts of funds at one time and to maximize interest earned on accounts if an emergency should occur. For example, instead of placing $5,000 in one CD with one maturity date, an investor can buy five $1,000 CDs with varying interest rates and maturity dates. This strategy, which is also used frequently with bond investments, is known as laddering.
Another important investment pre-requisite is adequate insurance. Every day, investors are exposed to risks which can cause a financial loss. Accidents, property damage, illness, and death are risks that people face for which insurance is used to protect against large financial losses. Other risks such as the possibility of being sued or becoming disabled and unable to work are also important.
Appropriate risk management strategies provide protection against catastrophic financial losses, regardless of the cause. Without adequate insurance, many people would have to go into debt or sell investments set aside for financial goals if an accident, illness, death, or other financial disaster occurs. Good comprehensive insurance coverage against severe setbacks is essential. Important areas for coverage include life, health, homeowner’s or renter’s, auto, disability, and liability insurance.
If you have large credit card balances, it is a good idea to repay them before starting an investment plan. Managing credit wisely can often provide a greater return on monies than many investment strategies (e.g., you will “lose” money by paying 18% interest on a credit card balance if the same amount is invested in a mutual fund earning only 8%). Repaying high interest rate loans and credit cards can also free up money that can be used for future investments.
In addition to interest rates, look at the total amount of consumer debt owed. If you are committed to spending more than 15%-20% of take-home pay for debt repayment (credit cards, car loans, education loans, etc.), look for ways to reduce the cost. One way to do this is with a debt repayment calendar from www.powerpay.org With a PowerPay calculation, the once a debt is paid off, the previously paid monthly payment is added to the amount paid to remaining creditors, thereby shortening the total repayment time for debts and lowering the amount of interest paid.
A final investment pre-requisite is financial goals. Goals provide motivation to set aside money instead of spend it. By identifying specific goals, investors can select appropriate investment products to match them. For example, a money market mutual fund or other cash asset is appropriate for a goal less than a year away and individual stocks or stock mutual funds for goals that are five or more years in the future.
Make your financial SMART goals: SPECIFIC with dollar amounts and dates; MEASURABLE by determining regular amounts weekly, bimonthly, or monthly to set aside to accomplish goals; ATTAINABLE given your financial situation; RELEVANT and REALISTIC and with a specific TIMELINE for accomplishing your goals.
Check out our Archived Monthly Investing Messages.