Yesterday I posted an article which showed that women are better than investors than men, but knowing you have the potential to be a good investor is of no use, unless you know where to start. So welcome to the Money Mummy school of investing! Every Thursday I am going to publish a post which guides you through the key principles that you need to know when making your first investment decision. Successful investing is not difficult and has nothing to do with luck. There are a few fundamental ideas that you need to know which will greatly increase your chances of success and help you avoid disasters. So let’s get started.
Before you invest a cent, there is one very important thing you must do and that is make sure your “financial house” is in order. You must be very clear about how much debt you owe and what type of debt it is. Generally speaking there are two types of debt, good and bad. Good debt is debt used to purchase things that increase in value such as a home loan, investment property loan or a loan to purchase shares (more on this later). These types of debt are classified as good because while you are paying interest on the loan, hopefully, the value of the asset purchased is increasing at a faster rate and you are financially better off.
Borrowing money to purchase things that fall in value is known as bad debt. Borrowing to buy a car is a classic example of this. It is widely reported that most new cars loose 30% of their value in the first year, so the asset is worth less than the value of the loan at the end of year one. Credit card debt and personal loans for holidays are also generally considered bad debt. Bad debts, particularly credit card debt, must be dealt with before beginning to invest as the interest charged on these cards of around 20%, far greater than the 10% average return for Australian share market (1983-2012). In this case, the best use of your money is to pay off the cards using the strategies outlined in my post “Top Tips For Getting Rid of Your Credit Card Debt”. This will give you nearly a 20% return on your money, risk free, it is difficult to get an investment return to beat that!
The next thing you need to do is make sure you have an emergency fund saved in cash. Six months of after tax income should be saved to ensure that you have the confidence to deal with any bumps in the road that life might bring, a new baby, losing your job, those little things that life throws at all of us that would otherwise knock you off balance. Yes, agreed with current low interest rates savings accounts are not sexy investments, but your money is safe and easy to access should you need it, which is the whole point of having an emergency fund. For me the best way to save is to use direct debit. This ensures the money is whisked away to a separate emergency fund account, before I have the chance to get my hands on it. Shop around for the best rate you can and don’t be afraid to move should a better deal come along. To help you compare the myriad of products out there some of my favourite comparison sites include:
Once your financial house is in order, credit cards paid off and your emergency fund well under control, you are ready to move to the next step, understanding the crucial principles of risk and return, and figuring out where your own risk tolerance lies. Understanding these principles will guide your investment strategy. Many people forgot these basic principles during the financial crisis and paid a hefty price for it, next week I will explain why. Stay tuned!
If you liked this post check out the rest of the series by clicking on the links below: