My fellow bloggers and I were having a discussion the other day, and the topic turned to our personal investments. We were talking about robo-advisors, retirement accounts, etc., and we touched briefly on having an emergency fund. While fairly self-explanatory, an emergency fund is a very liquid account set aside for when something unexpected happens. Hopefully the emergency fund is never needed, but the point is to have money to fall back on. The recommended amount is around six months non-discretionary expenses, but it can vary. When we were discussing this, we all acknowledged having an emergency fund was important. Clearly, an emergency fund is not as exciting as other areas of finance, but we understood it was a prerequisite to investing. This got me thinking - what should a person do before he or she begins investing? While this isn’t a complete list, here are a few points to consider:
- Establish an emergency fund of around 6 months non-discretionary expenses held in a liquid form, meaning quickly convertible to cash, to be used only in immediate-risk situations.
- Meet “bad” short-term debt obligations such as recurring credit card debt.
- Have a sense of your risk tolerance and risk capacity.
- Have a plan. An analogy I like to use is making travel arrangements: you wouldn’t decide between a bus, a car, or a plane until you knew where you were going. Similarly, you shouldn't decide what investment vehicle to use until you form a plan. This may include considerations such as taking advantage of an employer match.
These actions are not exciting and attention-grabbing, but they are extremely important. If you don’t have an emergency fund and you have credit card debt, take care of those right away. Furthermore, if you don’t know your risk tolerance and you don’t have a plan, focus your efforts away from investing and towards these pursuits first.