Before you start investing do these three things
In the My Own Advisor inbox I continue to get emails from readers about starting their investing journey. I’m going to revisit a few things I strongly believe in that should help you out on that. Let me know your thoughts and whether you agree (or disagree) with these suggestions in a comment below.
Do this item #1 – net worth calculation
Figure out where you are. What I mean by this is, figure out your net worth. What are your assets? What are your liabilities? What is the difference between those two values? Knowing what you’re worth (or what your family assets are worth) can be important indicator of financial health. For most people, one of your long-term financial goals should be to increase your net worth over time – that is increase your assets, decrease your liabilities, or both at the same time.
Do this item #2 – cash flow calculation
This is another financial indicator. Are you running a surplus every month? Are you running a deficit every month? This is another basic financial principle. Yet the fact that many people can’t pay off their credit cards every month, nor can they pay down their line of credit over time, is likely an indicator they can’t manage cash flow. I suggest you stop wondering “where does all your money go” and do some analysis. I found the folks at TD Bank actually have a rather nice personal cash flow calculator to use – try it out here. Ultimately you want to be running a surplus with your money every week or every month.
Calculate your monthly expenses and subtract your expenses from your net income (that is the money you actually take home). If the result is negative, that means you spend more than you earn – which isn’t sustainable. If your result is positive, that’s a good start, but by how much? To invest your net income should ideally exceed your expenses – with money to spare – which leads me to item #3.
Do this item #3 – establish an emergency fund
Personally, don’t listen to anyone very long who says you don’t need any emergency fund of any size. These people haven’t had a major emergency in life yet, or they have plenty of assets as to not worry about any short-term cash emergencies, or they’ve been very lucky in life thus far. Accept it or not, $hit happens to the best laid plans. In my opinion, keeping some cash on hand is a hedge against the unplanned and unforeseen – covering some “what ifs” in life.
Before you start investing do these three things summary
Before you start investing I suggest you do all these three things. I suggest this because…
- If you’re net worth is negative (and that negative number is large), you should focus on getting a handle on your liabilities first. You should focus on killing debt as one of your financial priorities.
- If your cash flow is negative, meaning you cannot run a monthly surplus, you realistically you have no money to invest. You should focus on becoming cash flow positive before you invest.
- If you don’t have any emergency fund, meaning you can’t cover any short-term expenses without tapping credit or going into debt, you should likely put your emergency fund in place before you invest.
These are just my suggestions based on what has worked out for my wife and I to date – your mileage may vary. As always let me know your thoughts.
All great ideas and probably serve as great starting points. You can’t invest if you don’t have the excess cash flow/savings to do so. One thing though, if you can get your cash flow positive, it is possible to begin investing while paying down debt at the same time. That’s important for younger people (like my age) to understand as they navigate through student loans. Just some food for thought haha
Thanks for the great read!
I had student loan debt when I was younger. I know what that feels like. Kill it early is my advice.
We normally keep a close eye on expenses and maintain a simple but effective spreadsheet that lets us see what is going out. By entering expense info almost daily, we get a very quick indication that we need to cut back.
However (there always is a however),this past month we didn’t bother keeping track of golf expenses for acouple of weeks, we just charged them. My that was a mistake, your point about understanding cashflow is so important..
We do forecasting in our house Richard. We avoid tracking every single dollar spend in a long because it’s too time consuming and our credit card statements do this work for us. We have a good handle of forecasts and that works for us, for the most part.
Great points Mark.
I would also agree with some of the other comments concerning learning about investing first, and then getting started invested once you also have a reasonable handle on net worth, and a start on your emergency fund.
Tracking cash flow to the penny…yes. We do and it’s not difficult.
Time, knowledge and discipline will be your friends.
Learning about investing can be a challenge. I sadly didn’t get my act together until about age 30, so I’ve really only been “investing” for the last decade or so. If I know in my early 30s, what I should have known in my early 20s, I’d likely be semi-retired now. Ah well, such is life.
The emergency fund continues to grow by $50 per month. Not much but every bit helps for the future and having a small cash buffer.
You got your act together before most. Some never get their act together.
I agree on the learning. Takes time and never really ends.
Almost all of us are the same on what we know now vs what we knew back in our 20’s. That applies to many things outside of finances too.
Good job on the emergency fund. A buffer is a good thing.
The way we track cash flow is strictly from our chequing account. Everything flows in and out of it. Almost all charges are on visa and for detail we reconcile the statement. That’s it as far as detail.
Yes, you live and you learn. At least we hope we do 🙂
I’d throw a disclaimer in there that some things, while being investments, might have priority. For example an RESP. When there are government or employer contributions on the table it might be a real good idea to take advantage of them as soon as possible. Or maybe a large income windfall that could be sheltered in an RRSP to avoid a particularly high tax bracket. Other than things like that, knowing expenditures v. expenses is probably a very good place to begin.
What better starting point!
Personally I’d tell the person to track things down to the Penny! Otherwise they might ignore the coffee or coke, the $5 dollar lotto, and any number of small amounts. But once they get into the habit of tracking ALL expenses and recording them, they can accurately calculate 1 to 3. In fact those small purchases soon amount to fairly large expenditures.
To the penny – that’s very detailed!
Definitely understanding your expenses, big and small, is just good money management – agreed!
When my wife kept track of our expenses, I clearly remember how upset she would get when the cash in her purse didn’t balance with the cash balance in the accounting account. It was almost a game to see which of us would miss or be out on our cash. Bank rec’s were never out. For the kids we just recorded what we gave them, not what they spent.
If #1-3 all ‘Pass Go’, I’d expand on #4: save for one year, like into an actual crappy savings account. During that year, educate yourself on investing and investment and develop your over-all investment plan/strategy/goal before you put even one dollar into any investment. That single year will instil a great saving habit (if it doesn’t, perhaps try for another year), as well as giving you a tidy sum of cash to start with (instead of nickle and dime-ing).
Read, read, read. Open up a few PRACTICE accounts with different discount brokerages. Etc.
But that’s just my opinion.
“…Like into an actual crappy savings account.”
I had a laugh at that.
We don’t nickel and dime – no point. I do believe however following these three things will help set up most Canadians on a good path, if not already done.
Read, read and read some more is excellent advice when it comes to investing.
What do you think is a good rule of thumb for the size of the emergency fund? 1 month’s expenses? 2? I personally like to have some of my emergency fund in cash in the event of banking disruptions.
Tough question for me to answer because everyone’s needs are different. I will say having at least a few thousand in the bank is a good start for most working Canadians to cover a few short term emergencies or expenses.
I’d aim for bare bone cost monthly cost of living times three months. Always hard to tell but let’s say you lose your job – how long until you find another one? Varies from city to city, year to year, industry to industry etc. but 3 months has always been the “magic” number in my head.
That’s a realistic number Max – 3 months. I would say at least 1 month of expenses is likely the minimum most Canadian families should have in an emergency fund. I suspect that amounts to a few thousand bucks. I suppose folks could always steal from their line of credit but having a fat line of credit and losing your job wouldn’t be very much fun.
I totally agree with getting a handle on personal finance and knowing where you are at before investing. Some debt have interest that no investment approach can keep up with so yeah, get rid of those debt first.
I would also say as a #4 that you should outline what you want out of investing. That one goal can start to establish how you will approach investing.
Great point – you need some level of knowing where you are before you figure out where you want to be.
Interesting post. I’d say that I agree with you, but that it’s OK to do “lite” versions of these 3 steps. For example, you don’t need to know your net worth down to the last $10 to decide whether to pay off debts before starting to invest. It’s a good idea to have a handle on cash flow to look for ways to control spending, but you don’t necessarily need to complete this before beginning to invest. If your net worth has been rising for the past 3 months, that’s a good sign that your cash flow can handle some investing. If you’ve decided you want a $10,000 emergency fund, but you’re only at $2000, I see no problem with starting to invest modestly at the same time as slowly building the emergency fund.
I see a lot of folks really get “bogged down” in the numbers, and lose track of the forest for the threes, so I think MJ’s points are valid.
Figure out how to start, you can adjust later.
It’s true “the math” scares people but it’s essential to figure it out.
I didn’t necessarily think these things are absolutes but I do believe it’s far from ideal to start investing before you understand these three things. Your example of the $2k fund vs. $10k is a place we were in for many years but now we’re over the $10k mark – and that’s a decent security blanket for us. One we’ll try to keep building by another $1k or so every year going-forward while investing.