As soon as you begin to bring in enough money so that a portion of it may be set aside for investing, a plan is necessary to take full advantage of that money. The amount of money available to invest also plays an important role in what investments can be purchased. Some investments are subject to limited access because they require certain minimum amounts. More generally, investing a greater amount of money opens the door to a portfolio with more risk and potentially greater returns. However, despite the importance of investing to your overall long-term financial situation, money for health, auto, and life insurance and retirement plan contributions should be a higher priority and should be budgeted for before beginning to invest. Additionally, investing should begin after high-interest debt, especially credit card debt, is paid off. Because after-tax returns will probably not exceed the interest rates paid on credit card debt, paying off the debt first will increase the amount of money you have each month.
After subtracting out essentials and debt, the first division to make within available funds is between savings and funds to invest. Savings allow for access to cash without the fees and lost opportunities associated with removing money from investments ahead of schedule. They should be highly liquid and will usually be located in a savings account, CD, or another safe low-yield investment vehicle. Savings should include an emergency fund and funds for any major near-term purchases. To create a sufficient emergency fund, you should amass enough cash to pay bills for a couple of months in the event of unemployment or cover the costs of major auto repairs or similar unexpected major expenses.
Once those emergency savings are set aside, you can make decisions about where to invest the remainder of your money. These funds differ from emergency savings because they will be expected to outpace inflation, taxes, and other drains on finances to serve as a source of income and security over the long term. In order to achieve higher returns, your money will be subject to a somewhat higher level of risk than for the emergency funds you put in the safe but low-interest investment. One of the most important aspects of investing is determining time horizons. Put simply, it is crucial to know when you will need the money. Common time horizons are based on large future expenses, such as retirement, college, houses, or cars. Knowing when money will be needed allows for the most effective investment strategy to be tailored to fit the specific goals that have been outlined.
When funds for investing have been earmarked, it is time to decide how those funds will be augmented in the future. There are a variety of plans to maintain a steady pace of contributions to investments. Of course, the amount invested will have to be adjusted periodically as income and expenses fluctuate, but developing the habit of putting away some amount of money each month is an important part of building a successful portfolio.
Many people believe that long-term financial planning is only important for the wealthy, or that it’s a task best left to professionals, but in reality, there are many steps that the average investor can take to solidify his financial future. The first step in the financial planning process is to determine net worth. An investor’s net worth will serve as a jumping-off point to begin thinking about his financial future.
Net worth is simply the sum of an investor’s assets minus the sum of his debts. Assets include all of an investor’s assets including real estate, securities, valuables, and cash. The value to use in the calculation is the amount that all of these items could be sold for at the present time. Debts include mortgages, car loans, and credit card balances, and should be subtracted from the assets to determine net worth.
Once this financial snapshot is detailed, you can address your specific goals. Always remember to think about both assets and liabilities. It is always nice to acquire new assets, but if assets are appreciating more slowly than debt is growing, net worth is decreasing. It is important to strike a balance between building assets and managing debt.
The goal of financial planning, then, is simply to find ways to increase net worth at a steady pace. Saving money, allowing assets to appreciate, and paying down debt will all contribute to this goal. Incoming cash minus expenses will reveal how much money is available to an investor at the end of a given time period. If this value is negative, expenses are outpacing income, and the difference will have to be paid from savings, decreasing net worth. This is obviously dangerous because if the situation doesn’t change, eventually the reserves will run out. If income sufficiently outpaces expenses, it might be time to start contributing to net worth in earnest by acquiring assets and eliminating debt.