Investing is often seen as the glamorous side of personal finance. The sexy, glamourous, interesting, and exciting part. It’s hard not to love the idea of easy wealth piling up so rapidly that your biggest problem is where to put it.
Topically, investing sells. There’s an abundance of articles about “investing like the pros”and “how to beat the market.” Unfortunately, if you invest like the pros, you’ll rarely beat the market.
But investing isn’t the best place to begin a journey to becoming financially literate. There are more important priorities. And investing skill is a rare commodity. Few people actually beat the market across long periods of time. Even when it’s time to invest, it’s more important to understand your investments than it is to be highly competent at selecting them.
Investing without a solid financial base is similar to building a structure without a foundation — there are gonna be problems. Let’s look at what the bigger financial priorities are.
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Budgeting doesn’t have the cachet of investing. It’s simply not seen as glamourous. It’s easy to envision high society people talking up their latest market successes; talking up their latest budgeting tips, not so much.
Budgeting is, however, the foundation upon which a solid financial future is built. A budget is simply a spending plan for your income or incomes. You decide how much to spend on various things, how much to save, and how much to invest. It can be very formal or kinda loose. Either way, it’s the roadmap that shows how you allocate your resources.
If investing is the destination, budgeting is the GPS.
Typically, when people try to maximize their investments prior to budgeting, it doesn’t last. People tend to overestimate the amount of their monthly incomes that they can allocate toward their goals. And if they overestimate them absent other changes, there will be months when the resources simply aren’t there. So they stop.
Budgeting allows you to establish a systematic allocation toward your investments that you can maintain on an ongoing basis. It eliminates the unaffordability of guestimates and brings predictability to the process. Failure to budget reduces the likelihood of maintaining an investment plan.
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2. Emergency Fund
Nothing derails financial plans like the lack of an emergency fund. Unexpected expenses aren’t unexpected in that we don’t think they’ll occur. We can expect them to occur, but we just can’t always predict what they’ll be or when they’ll happen. But they do happen, whether it’s unforeseen medical expenses, a major car or house repair, or the loss of a job. Life is full of surprises, and those surprises often cost money.
Building investment accounts prior to building an emergency fund often results in problems when an emergency appears. If you have no emergency fund, but do have some investment accounts, you may end up raiding the investments to meet the emergency. This can mean additional fees or the need to sell when it’s not a good time to sell — a whole host of problems. Or you might put the emergency costs onto a credit card and incur outrageous costs to make use of a bank’s funds instead of your own.
Either way, trying to build investments without first building an emergency fund can cost you dearly when an unforeseen expense crops up.
An emergency fund provides a financial buffer against unforeseen expenses, which in turn allows you to leave your investments intact and weather temporary financial storms without the high costs associated with being unprepared for such expenses.
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Inadequate protection can ruin your financial well-being. Most people in the U.S. aren’t adequately insured in one or more areas. For instance, many people don’t carry sufficient life insurance coverage to allow for their survivors to continue their lifestyle in the event of the policyholder’s premature death. Even fewer people carry sufficient long-term disability insurance to provide for the family’s needs.
Protection should extend beyond life and disability needs. Sufficient protection of valuable assets and sufficient liability coverages are also essential to protect yourself and your family from going backwards financially in the event of a major unfortunate life event.
The purpose here isn’t to discuss what needs to be protected and why. We have other resources for that. But we insure against those things that have a lower probability of occurring, but very large costs if they do occur.
We know these things will happen to some people. We simply need to be prepared so that our financial futures aren’t devastated if they happen to us. Otherwise, any investment planning is at risk of everything going toward the emergency, leaving us with nothing for the future. And that’s not a prudent risk to take.
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4. On to Investing
Once you’ve built the foundational elements of a solid financial future, it’s time to look at investing.
But it may not be time to try to become an investing wizard. Perhaps not now, perhaps not ever.
For most people, investing knowledge is more important than investing skill. Investing knowledge involves understanding different types of investments and how they work. It includes knowing how they come into being, how they fluctuate in the market, what drives their changes in value, and what the specific risks are for each investment. This is important, but still not essential.
Investing skill is the ability to select appropriate investments for your financial goals without incurring undue risk. Many investors try to hone their skills in an attempt to produce market-beating returns, but even among professionals, few accomplish this.
It’s not that it can’t be done. However, it requires a lot of time and commitment. And even then, it’s not guaranteed. Most investors will never be able to beat the market on a consistent basis. But they also don’t need to.
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No Need to Be a Genius: Finding Alternatives
There are a lot of alternatives to becoming an investment superstar. For the vast majority of people, these are better options.
There are a lot of index-based investments that allow you to participate in markets without more risk than the market has, and with the likelihood of similar returns to the market.
There are a number of asset allocation funds that further divide your investment into a variety of asset classes in an attempt to produce better long-term risk-adjusted returns. And some of them are time-horizon funds that change the allocation across time, reducing your investment risk as you approach your goal.
Enlisting Help With Investing
There are many investment professionals you can work with who will manage your investment portfolio based on your risk tolerance and investment objectives.
You also have technology solutions. Robo-advisers can be a viable alternative to doing all the work yourself.
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In the End, How Important Is Investing for Your Financial Future?
It can be time consuming to learn about different types of investments and how they might help you achieve your goals. For a good percentage of people, this may be a worthy investment of their time. It will help them steer the course through difficult times.
It’s far more time consuming to learn how to produce above-average investment returns on a long-term basis. Most who try won’t be able to do it. And many will lose a lot of money trying. If that’s your passion, that’s great. But don’t sweat it if it’s not.
Being financially literate means purposefully making prudent decisions with your money. It doesn’t mean you have to spend a lot of time doing something that you don’t enjoy and that almost no one is very good at doing.
You don’t need to be an above-average investor to do well. In fact, you don’t really even need to put a great deal of time into trying to understand where to put your money, nor try to wrap your head around why you want negative correlations or what “style purity” really means. You simply need to invest from a solid foundation and make use of the many tools available in the marketplace.