“Most people don’t plan to fail, they fail to plan” -John L. Beckley
It’s important to know what you want to accomplish with your investments before you actually invest in the stock market. For example, you might want to invest in the market with the aim of purchasing a home, fund a child’s college education or build an adequate retirement nest egg. If you set the financial goals at the outset—you are more likely to reach them.
You also want to get a handle on the basic finances such as how much money is coming in and going out. This will help you control spending and manage debt. Most importantly, it will help you methodically save and invest in the stock market, which is essential to building your net worth. Moving on, financial planning will determine your exposure to the market and enable you to maximize the market returns.
Use the information below to help you establish and meet your financial goals.
Set your financial goals
Just as in other aspects of your life, setting financial goals is a tried-and-true way to reach those goals. You can create a list of your financial goals on your own or you can work with an investment professional who has experience in this area. To make the most of this exercise, assign each of your financial goals a price tag and a time frame. Then, identify how investing in the market could assist you in meeting your goals.
One advantage of working with an investment professional is that he or she may provide the encouragement you need to move from thinking about your goals to actually listing them out and taking steps to achieve them. While everyone’s circumstances are a little bit different, there are essentially four steps to creating a strategy for meeting your goals that will work for just about every person and situation:
1. Identify your most important short-, medium- and long-term financial goals.
2. Estimate how much each of your goals will likely cost.
3. Set up separate savings or investment accounts for each of your major goals.
4. Choose investments suited to meeting each of your goals based on your time frame and your tolerance for risk.
Before you can choose investments to meet a particular goal, you need to have an idea of what the goal will cost and your time frame for meeting the goal. It’s relatively easy to anticipate the costs of short-term goals, since they probably won’t be significantly different from what they are today. Estimating the costs of goals that are further in the future, especially major ones like the cost of college or retirement, can be a bit trickier.
For goals that are more than a few years away, you also need to consider the impact of inflation on your assets—something you can figure out using an online calculator. Last seven years’ inflation has averaged about 7 percent per year. And the costs of tuition at colleges typically rise even faster. That means you’ll have to earn enough on your investments to offset these rising costs.
Calculate cash flow
Calculating your monthly cash flow will help you evaluate your present financial status, so you know where you stand financially as you prepare to invest.
Begin by looking at your monthly net income—the money you take home every month after taxes. This includes your salary and other steady and reliable sources of income, such as income from a second job, child support or alimony that you receive or social security. If you already own some investments, you may be receiving dividend or interest payments, a factor that amounts into income too.
Then calculate your average monthly expenses. These include your rent or mortgage, car lease or loan, personal loan, credit card and child support or alimony payments. Also include money for groceries, utilities, transportation and insurance. Don’t forget the money that you spend on items that are ‘discretionary’, rather than necessary—for example, cable television subscriptions, gym fees, clothing, gifts and the like.
Average your actual expenses over a three-month period to come up with a reliable monthly estimate for your total expenses. Subtract your monthly expense figure from your monthly net income to determine your leftover cash supply. If the result is a negative cash flow, that is, if you spend more than you earn, you’ll need to look for ways to cut back on your expenses. Similarly, if the result is a positive cash flow but your spending nearly equals your earnings, it might be too soon to start investing right now.
To invest, your net income must exceed your expenses—with some to spare. If this is not the case, look for the expenses you could eliminate or reduce. Maybe some of your discretionary expenses are luxuries that you could give up. Perhaps a debt refinancing or consolidation could reduce your monthly payments. A financial professional may be able to help you with these matters.
Know your net worth
As you prepare to invest, you’ll need to assess your net worth. It’s not hard: add up what you own and subtract what you owe. Creating a net worth statement and updating it each year will help you monitor your financial progress and meet the financial goals. It will also enable you to calculate how much you have (or don’t have) to invest.
The first step in this process is to determine the total amount of your assets. Assets are your possessions that have value—for example, money in bank accounts, stocks and bonds, personal property, your home or other real estate. Once you’ve calculated your assets, determine the total amount of your liabilities. Liabilities are financial obligations or debts. Examples include credit card balances, personal or auto loans and mortgages.
Once you’ve calculated the total amount of your assets and liabilities, subtract the total amount of liabilities from the total amount of assets. Ideally, you’ll want to have a greater amount in assets than liabilities. If your assets are more than your liabilities, you have a ‘positive’ net worth. If your liabilities are greater than your assets, you have a ‘negative’ net worth. If you have a negative net worth, it’s probably not the right time to start investing.
You should re-evaluate your finances and determine how you can decrease liabilities—for example, by reducing your credit card debt. If you have a positive net worth and cash flow, you’re probably ready to start an investment plan. Here’s a simple net worth worksheet that can help you get started. It’s a good practice to calculate your net worth on a yearly basis.
Start an emergency fund
As you prepare to invest, it’s important to set aside some money—about the equivalent of three to six months of living expenses—in an emergency fund. There are times when people become ill or are injured in accidents. Employers lay off workers. If something unexpected happens to you, having the money you need to pay the medical bills or see you through the weeks or even months of being out of work will help to keep you out of debt. If you already have investments, an emergency fund also will help you meet your expenses without disrupting your investment plan.
The best place for your emergency fund is in a liquid (easily accessible) account. A liquid account might be a regular savings account at a bank that provides some return on your deposit and from which your funds can still be withdrawn at any time without penalty.
Manage your debt
Most people carry debt in one form or another and you are probably one of them. Your debts, also called liabilities, can include the mortgage on your home, loans for automobiles or education expenses and, of course, credit card balances. Virtually all of these debts come with an obligation to pay monthly interest on the balance you still owe. As you prepare to invest, take stock of your current debts and try to pay them down. The less money you put towards paying off outstanding debts and interest charges, the more you will have to save and invest for your future.
If you use a credit card to make purchases, you should know that they have advantages and disadvantages. If you spend within your means and pay off your balance on time—and in full—each month, credit cards can serve as a safe and convenient substitute for cash. And there is the added bonus that they can help you establish and maintain a solid credit history.
Few money-management strategies pay off as well as, or with less risk than, paying off all high interest debt you may have. If you can’t pay off credit card debt immediately, work out a structured plan to pay off the balance as quickly as possible. You’ll save money in the long run.
Planning is brining the future into the present so that you can do something about it now. Plan prudently and be a smart stock market investor.