The word “investing” has been searched the highest this March 2020 according to Google Trends, a website that tracks how many times a word has been searched using Google search engine. March 2020 is the highest since they started tracking word interests back in 2004. Since the start of the Covid-19 pandemic, a lot of people are staying at home and looking for other ways to earn extra income. Some have been trying to capitalize on markets and commodities dipping to buy cheap assets. No matter the reason is, here are 5 things to consider before letting go of your hard-earned money on investments.
#1 Emergency Funds
The ideal for an emergency fund is between 3 to 6 months worth of expenses. If your monthly essential expense is $2,000 for rent, food, utilities, and debt repayments then you should have $6,000 to $12,000 as an emergency fund. This fund should cover your essential expenses in the event you lose your job or business. Three to six months should be enough time to find another job or another income source.
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Emergency funds should be kept in a highly liquid, low-risk investment vehicle such as a savings account. Yes, a savings account in a bank is already an investment vehicle as long as it earns interest. It is not advisable to invest emergency funds in stocks or equities as these are high-risk speculative investments. It is also not advisable to place in bonds or balanced mutual funds as they are not very liquid or not easily convertible to cash.
I don’t want $12,000 to just sit in the bank, are you crazy? Fine, do half-half, 50% in the bank, 50% saved in low-risk investment at least. Emergency funds should be just that – an emergency fund. They are not investment funds or business funds, you should have a separate fund for that.
People are realizing the importance of an emergency fund now more than ever. “I have a very stable job…”, “I have been with the company for 10 years…”, “it’s only for those with no stable job…” Boom! Covid-19 hits, where are you now?
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#2 Protection
A good financial plan is a safe financial plan. What’s the use of all your investments if it’s locked for five years and you need to pay hospital bills today? Or if all your money is invested in real estate and you lose your job today? Do not go straight to investing if you have inadequate protection otherwise you may need to withdraw your money (or sell properties) at a loss when all of a sudden you encounter an emergency.
Whenever applicable, you should first secure an HMO or health card to cover your medical expenses as medical emergencies can happen anytime. Next is an accident, emergency, critical illness, and disability insurance – this is different from HMO or health card. It may sound a lot but usually they come in a package. HMO or health cards cover your immediate medical bills while disability and critical illness insurance give you a sum of money upon diagnosis. If you have dependents then life-insurance is a must. If you are already adept in investing, separating life insurance with investment is the better way to go. Next is insurance for your assets. If you are dependent on income-generating assets eg. rental properties, secure them first as you cannot monitor what your tenants do 24/7.
Insurance protection is not a liability, it is a necessary expense of a good financial plan.
#3 Time Horizon
Beginners in investing forget the importance of a time horizon. They think it’s all about the interest or rate of return. The time horizon answers the question, when do you need the money. Knowing this can help you choose the right investment vehicle for you.
Time is essential to growing your money. Anyone claiming 5% growth a month or 50% interest per year is a scam or is extremely risky. Some investment vehicles such as bonds and mutual funds will incur fees when you withdraw before maturity. Equity funds or index funds take time to be profitable as stock prices (normally) do not increase exponentially overnight.
When you have a short time horizon, you should invest in low risk, conservative investments. When you have a long time horizon, you can invest in a more aggressive investment vehicle. Why? Because with longer time horizons, you can still recover your money in risky investments when losses come.
“One to three years in investing is considered short term. Three to ten years is medium-term and more than 10 years is long term.“
Say you are a 30-year-old father with a 1-year-old son. An investment time horizon for you might be, down payment for a car – short term, house construction – medium-term, next baby – short to medium term, tuition for son’s college – long term, retirement funds – long term, extra cash during this Covid-19 pandemic – short term. The time horizon will be different for every individual. The important thing is to identify them. One to three years in investing is considered short term. Three to ten years is medium-term and more than 10 years is long term.
Below are different investment vehicles according to time horizon, risk, and return:
#4 Pay Off High-Interest Debts
Why is it important to pay high-interest debts? Well, it’s very simple. The purpose of investing is to earn money. If money earned through investing is used only to pay off interests, then you are not really earning anything.
Whenever possible, pay off your debts or keep it to a minimum. As a rule of thumb, keep your total monthly debt payments (credit cards, car loan, home loan, other loans) to less than 36% of your gross monthly income. The total mortgage for a house should not exceed 28% of your monthly income. This is what lenders generally use to determine your eligibility for a loan. If you are earning $4,000 a month, the maximum amount you can allot to pay a home mortgage is $1,120 ($4,000 x 20%) including principal, interest, taxes, and insurance. Total debt should not exceed $1,440 ($4,000 x 36%).
According to Investopedia, if you are planning to invest in a house, a good rule of thumb is 2 to 2.5 times your gross annual income is a house that you can afford. If you are earning $100,000 per year, you can afford a $200,000 to $250,000 house.
#5 Invest in Knowledge
One of the best investments you can do in uncertain times like today is to invest in yourself. Stocks may fall, markets may crash but no recession can take away knowledge learned to increase your value. Take this opportunity to learn a new skill.
If you choose to invest or trade the stock market, do not rush, learn as much as you can, and find a trustworthy mentor. Nevermind if you miss the dip a few weeks ago, there will always be other opportunities. Rushing to invest without understanding the fundamentals and psychology of trading is more detrimental in the long run.
Check out some books below:
- The Intelligent Investor: The Definitive Book on Value Investing – all about value investing.
- The Only Investment Guide You’ll Ever Need – practical tips about investing.
- Rich Dad Poor Dad – the psychology of investing in assets.
- Mutual Funds for Dummies
- Investing 101: From Stocks and Bonds to ETFs and IPOs, an Essential Primer on Building a Profitable Portfolio
I always wonder how people can decide where to invest without knowing the concept of the future value of money. Do not start investing if you don’t know the following concepts: time value of money and compound interest, internal rate of return, diversification, risk tolerance, and inflation. Knowing these concepts can help you decide a good investment program.
