How to Start Investing: Part 1

It’s Financial Literacy Month again!

How did you celebrate last year?

I bet your financial literacy party wasn’t as much of a rager as mine, which consisted of a comfy couch, a local craft beer, and a big pile of personal finance books.

This year, I’m bringing the party to you.

I’m going to teach you the basics of investing over the course of three short columns in three weeks.

In fact, it’s easier than that, because today’s isn’t really about investing.

Here’s the schedule:

Week 1: Before you invest
Week 2: The secret of great investing
Week 3: Staying in the game

Let’s go! (You bring the beer.)

Before you dive in

Investing is important, but it’s not so urgent that you need to start today.

Think of investing as Personal Finance 201. If you haven’t passed the 101 class, you’re not ready to invest.

Here are the four steps you need to take before putting your first dollar into stocks or bonds—plus one sneaky exception.

1. Save up an emergency fund

Why? It protects your investments from being raided before their time.

Access your retirement accounts before your retire, and you’re on the hook for a big penalty and a tax bill.

In his great book The Little Book of Safe Money, the Wall Street Journal’s Jason Zweig writes: “Just as travelers in the wilderness die without water, investors perish if they have no liquidity.”

Liquidity is a fancy term for cash or stuff that can be easily turned into cash.

A savings account is liquid. Home equity and comic books are not liquid.

Save up an emergency fund of at least a couple of months of expenses and keep it someplace safe and boring, like a savings account, even if the interest is paltry.

2. Pay off high-interest debt

Why? If you’re building up an investment account and simultaneously paying off credit card debt, you’re limping up the down escalator.

It’s all about compound interest.

(To a personal finance writer, everything is about compound interest. Hand them the latest issue of Cosmo and they will flip right past 37 pages of orgasm tips and find a paragraph about compound interest.)

If your credit card charges 15% interest and your investments are making 8%, you should put every last dollar toward the credit card and zilch toward investing.

Paying off the credit card is like earning 15% interest, risk-free.

What counts as high interest? You know it when you see it.

Credit cards, unsubsidized student loans, most car loans.

Frankly, I think it makes sense to pay off all debt before investing—even your mortgage and subsidized student loans—but I’m distinctly in the minority on this.

3. Understand what investing is and what it isn’t

Why? Reasonable expectations help you avoid scams and bad decisions.

Here, this one’s a little less ambitious. Investing, in short, means:

• Buying a piece of a company and sharing in its growth (stocks)
• Loaning money to a company or government and having your money paid back with interest (bonds)
• Buying land and sharing in the rising price of the land or rent payments from the people using it (real estate)

You are not going to get rich quickly by doing any of these things but using an investment calculator should give you a good understanding of how much you will get in a given time frame.

You’re not going to make 20% a month. You’re not going to make 20% a year—although in some years, you might.

Some years you will lose money. There aren’t a lot of sure things in investing, but that’s one of them.

If this makes investing sound boring, congratulations: You get the idea.

4. Read a book

Why? Because I’m cheating by making reading this book part of my supposedly short course.

I always recommend the same investing book.

It’s short, written by two of the greatest investment thinkers ever, found in most public libraries, and written in plain English.

The book is Elements of Investing, by Burton Malkiel and Charles Ellis.

By the time you finish reading this short book, you will know more about investing than practically anyone you know.

This may not make you more fun at parties, but it will make you wealthier.

5. Actually, do this first: get your 401(k) match

Why? A 401(k) match is the best-performing investment you’ll ever find. Ignore it at your financial peril.

If you have a 401(k) with an employer match, always contribute up to the match.

It’s okay to do this even if you have credit card debt or student loans or car loans. Get the match while you build your emergency fund and pay off debt.

This is the only thing that literally everybody in the personal finance game agrees on.

If we ever make contact with intelligent alien life, the first thing financial planners will ask the aliens is whether they’re maximizing their employer match.

(Although if the aliens are so intelligent, why do they still have employers?)

Next week: The secret to investing! (It’s probably not as exciting as I’m making it sound.)

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.

Source: mint.intuit.com