Thinking of putting your money to work for you? That’s a fantastic idea, especially when you consider the fact that the average interest rate for a savings account is 0.6%, while the average rate of inflation hovers around 3%. That means that while you may be making interest while your money sits in a bank account, you’re actually losing at least 2% a year in its buying power. Stocks, bonds, CDs, mutual funds, property, and other investment opportunities typically offer a better return that’ll help you outpace inflation and grow your wealth.
Before you jump into investing, though, there are a few things you should have squared away. Here are three personal finance tips to follow before investing.
1. Start with a Budget
“Budget” can be a four-letter word for some. After all, it sounds like a plan that puts handcuffs on you. Here’s what it actually is — magic. A budget can not only help you take tighter control of your money, keep you prepared for emergencies, and leave you with more at the end of the month, it can also play an even bigger role in your life, too.
Financial counselors often start new counselees with a spending diary. For a month, they must write down everything they spend, no matter how small or seemingly inconsequential. From this diary, trends start to emerge and people start to see where their money is actually going. Oftentimes, it’s not at all where they think.
Using this spending diary to make a budget will help you refocus your energy (and your money) on the things that are most important to you. It can force you to evaluate your trajectory in life and realign your financial goals to fit it, which brings us to our second point.
2. Make Clear, Attainable Goals
Use your spending diary and budgeting time to take a step back and define your financial goals in life. Do you want to work toward buying a home? Upgrading the car? Do you want to be able to use your money to help people in need? Pay off debts? When would you like to retire? Is seeing the world important to you?
Write these goals down and make sure the financial decisions you make are serving them. For example, if you need to pay down debts, you may need to cut the $5 latte or the streaming services to serve that goal. If you want to retire at X age, you’ll want to be putting a set number away each month that will get you there.
3. Determine Your Tolerance for Risk
You don’t need a business degree to become an investor, but you do need to educate yourself about your investment options and how they fit with your goals. The first step is to evaluate how much risk you can tolerate.
All investing involves risk. It’s the nature of the beast. However, there are ways to mitigate this risk by choosing investments that fit your style. Before you start buying property or trading stocks you need to decide how much risk you want to take.
Things like mutual funds, CDs and money market accounts are low risk, which makes them perfect for more conservative investors. Their rewards are often slow and steady, meaning you might not hit the jackpot in a matter of months, but your money will be consistently making more for you than it will be sitting in the bank. These types of investments are ideal for longer-term investing.
Individual stocks, crowdfunding, cryptocurrencies, and hedge funds are considered high-risk investments. They can pay off in a big way if you’re lucky, but they can also take a dive along with your money.
Maybe you know which category you fall under already. If not, choosing a mix of both can help you diversify and find a balance of risk and reward.