This is part 2 of my series on starting investing. If you had missed it, please do check out my earlier post.
There are many great reasons to start investing. But please hear me out first before you plunge in.
And do not worry if others tell you the best time to start investing was 20 years ago. Time is still on your side. At least I hope.
Here are 5 reasons you investing might not be for you, yet.
#1 You Want to Get Rich Quickly
Everyone expects to make money from the stock market. If not, why bother putting your money in it?
Contrary to popular belief, it is not as easy to make a quick buck from the market as the movies show.
If you are new the financial markets, you might want to stay away from speculative investments. These kind of investments are highly risky and you may end up losing at lot of money.
Here is a short video which explains the difference between saving, investing and speculating.
You may have heard the phrase ‘the house always wins’. The games in the casino are rigged to favor the house.
It is possible for players to win big from the casino. But is it probable? The odds are extremely low and only a few managed to do that.
Similarly, beating the stock market is a zero sum game – someone has to win and someone else has to lose.
The problem is you are competing with other professional traders or fund managers who are chasing the same profit as we are.
So if you cannot beat the market, join the market. Embrace passive investing (Which I will cover in another blog post for the future). You can read more about it in this article from The Balance.
#2 You Need the Cash
In order to grow you money, you need to commit your money. And if you want it to grow, you need to keep it there for a while, invested in the market.
So, the second point is: If you need the money, put it in a savings account or checking account in the bank.
Do not put it in the stock market because it is prices are volatile. You do not want a situation where you need to sell at a loss just because you need the money.
In order to avoid this situation, you will need to have:
- Emergency cash savings
Emergency Cash Savings
Your emergency cash savings is basically what it is – money saved for emergency events. Such events can be losing your job, falling ill, accidents and natural disasters.
A good place to start is to save up to 6 month’s of your monthly income. Why 6 months? I hear this all the time (6 months seemed like an arbitrary number to me. Is this number backed by data? I probably can do some research for a future article).
In the event of losing your source of income, you can tide through 6 months without needing a job.
If you cannot set aside that much you could consider setting aside 6 month’s worth of expenses. This is more aggressive but the idea is the same, you can live off your savings for 6 months.
For the more conservative folks, you can save more than 6 months. In fact, if employment is hard to find in your sector or country or when getting a new job at your age can take more than 6 months, please set aside more money. It really depends on your situation.
Insurance has an interesting origin which started in the form of bottomry where a the loans were written off in the event a shipment is loss in sea. I digress.
Insurance is basically a contract which protects us by reimbursement or a guaranteed payout in specific losses, damage, illness unfortunate events or death.
Health insurance helps covering healthcare cost in the event of illness. Healthcare costs can really eat up your savings and may force us to sell our investments.
Life insurance helps provide income for dependents in the event of death of the breadwinner of the family.
Other important insurance include disability or critical illness which affects our ability to work, sometimes permanently.
All these events can place a heavy financial burden and may force you to withdraw your investments to meet those needs.
A good analogy, which I had read recently in this article, is comparing savings and insurance as financial parachutes. It is vital to have two spare parachutes, before you take the plunge.
#3 You have Huge Debts
Pay off your debts. It is simple age old advice.
Imagine filling a bucket with water. However, to your dismay, you just realized this bucket has several holes in it. No matter how much water you fill, it leaks out.
If the water inflow is greater than the leakage, the bucket gradually fills up. But if the inflow is less than the outflow from the leakage, the bucket gradually empties up.
The bucket is our wealth. The water is the money we pour into investing. The holes are the debts we have.
Therefore, we should strive to keep debts low because debts will eat into our wealth – we have to pay back what we borrowed and pay additional interest on top of it.
There are two ways to fill up the bucket:
- Plug the holes – pay off all debts. Then pour water into the bucket
- Increase the water inflow greater that the water outflow.
Good vs Bad debts
There are good debts and bad debts. The definition usually depends on what the debts are used for.
Good debts are borrowings used to invest and reap a profit at a later time.
One common example is a mortgage, where we borrow to pay for a house which has investment value. A student loan is also another example where you borrow to get a degree which may land you a better job in the future.
Bad debts are borrowings that are used to purchase things that do not appreciate in value. These kind of debts someimtes also come with higher interests.
Common bad debts include credit card, payday loans or some form of high interest unsecured loan. Pay these off first as the interest payment will grow over time and it can easily snowball out of control.
Even if you think you can generate more returns than your interest payments, you are taking on far more risk as stock market returns are never guaranteed. What if there is a drop in the market? Some risks are not worth taking.
Eliminate all your bad debts first before even thinking about investing.
But what about good debts like my mortgage?
I am not saying you should not invest until you paid off all your debts.
Given sky-high property prices, some of us would have 30 years mortgages which would take a long time to pay off fully.
These kind of debts generally have lower interest, you can start investing even if they are not fully paid off. Sometimes, your investments might generate enough profit to pay off the interest from these debts.
This is like the scenario where we increase the water inflow without plugging all holes in the bucket. But the holes here are quite small so the leakage is very small.
In my opinion, I would focus on paying off debts first. But if the debt, such as mortgage is huge and has low interest, you can still start investing. However, you will need to stick to safer investment strategies because you have a huge debt to pay off.
But if you have the means to pay off your debts, why not do it first? Then you will have the peace of mind and focus on growing your wealth.
#4 Because I will Miss the Bandwagon if I don’t
Missed the bitcoin huge rally? I could have been a millionaire by now.
Missed the huge year end stock rally? This must be big. I have got to get in. Now!
This is herd instinct or in layman terms – Fear Of Missing Out.
This phenomenon occurs when investors do not behave rationally and overestimate the price of certain investments beyond it’s actual value.
Once you enter the market when it is rallying, chances are you are already too late to profit from it.
This is how financial bubbles form. As more people buy, the higher the prices go. As prices go higher, the more people will buy until the bubble pops.
Hence, try to understand the fundamentals of investing. Try to understand how markets behave. Try to understand how people would behave after all the market is the collective behavior of people.
Start investing because you have a plan and will follow it. Do not start investing because you are either greedy or fearful.
#5 You Don’t Have a Plan
This reason is related to my previous point. You need to understand at least what you are doing and not blindly following others or your emotions.
So before you start, think about what you want to achieve. Is it for buying a house? Is it for your children’s education? Is it for your retirement?
Once you know what the objective is for, you can then work out the time you need to achieve the goal and plan how much you will need to invest and how much risk can you take.
The shorter the time frame needed to achieve a goal, the more conservative your investing strategy needs to be.
If your goal is to not lose money but ensure your money does not drop due to inflation, you will need to stick to safer assets and low risk investments. This is generally referred as capital preservation – maintaining your wealth.
If your goal is to accumulate enough money to purchase something or generate a stable income, you may need to stick to some strategy that offers growth. This is generally referred as wealth accumulation – growing your wealth.
Therefore, you need to know why you want to start investing. Create a plan and strategy. Then implement the plan.
I did not write these points to discourage you from investing. But rather, my objective is to get you thinking holistically about your financial situation before you start investing.
I hope you had found these helpful.
Do drop me a comment if you disagree or if you have other points you would like to share.