Before you invest a single euro
Before you invest, you need three things: no expensive debt, a cushion for emergencies and money you won't need for a few years. If one of them is missing, investing isn't your next step yet.
Learning objective: After this lesson you can use three questions to decide for yourself whether investing fits you right now.
Almost every site about investing starts with the question of which stock to buy. A different question matters much more: is your everyday life stable enough that you can leave money untouched for a few years?
Sophie's Starting Point
Take Sophie. She has €3,000 in her account and finally wants to start with an ETF. At the same time her overdraft stands at minus €1,200, and her car is twelve years old. If she buys now and the clutch goes in autumn, she'll have to sell, maybe just when prices are low.
Three Questions Before You Start
Three questions help before you get going:
- Do I have debt that costs more than about five percent interest a year?
- Do I have an emergency fund in case the washing machine and the car break in the same month?
- Do I know how much is really left at the end of the month?
If you can honestly answer yes to all three, you can start. If not, you lose nothing. You use the time to lay the groundwork. The stock market has been around for over a hundred years, and it will still be there in two years.
There are three solid reasons for this order.
Fixed Loan Interest
The first is interest. An investment brings a return nobody knows in advance. A loan costs interest that's fixed. Paying off an overdraft at 11 percent saves you a sure 11 percent, and no tax is due on it. No stock portfolio promises you that.
The Time Factor
The second is time. Stocks pay off in the long run mainly because you can sit out declines. If you have to sell in the middle of a slump because your car broke down, a loss on paper becomes a real one. The emergency fund makes sure you can actually stick to a long investment horizon.
The Savings Rate
The third is your savings rate. Over many years, how much you pay in each month usually matters more than what exactly you buy. Someone investing €300 instead of €100 a month ends up well ahead of someone who stays at €100 and squeezes out two percentage points more return. Knowing your own budget is the most effective lever you have.
Data as text
The order is: pay off expensive debt, build an emergency fund, insure the essentials, invest.
Summary
- With high interest rates, paying off debt beats investing.
- Without an emergency fund you may have to sell at the worst moment.
- How much you save usually matters more than what you buy.
Did you get it?
Why is paying off an overdraft often better than investing?
Because the interest you save is certain and tax free, while an investment only promises an uncertain return.
Why do you need an emergency fund before investing?
So an unexpected expense doesn't force you to sell your investments at a bad time.
What usually matters more over many years, your savings rate or your choice of securities?
Almost always the savings rate.
Your task
Answer the three questions with your own numbers: the interest rate on your most expensive debt, the size of your cushion, and the amount that really is left at the end of the month. Then use the emergency fund calculator with your monthly fixed costs to work out how many months your cushion lasts. Write a yes or no behind each of the three questions.
Sources and further reading
- Household finance fundamentals, as recommended by independent consumer bodies and financial regulators.
Check your understanding
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