Especially for those new to investing, but even for those with more experience, there is one basic, fundamental question that is formidably difficult to answer: What do I do with my money?
It might seem like a simple question, but the simplicity of its wording actually hides the complexity of thought that its answer requires. Knowing what to do with your money is the central challenge of investing, and is in fact what keeps most away from investing in the first place. The financial world for many is a foreign one that looks like a minefield from afar.
While there is no easy answer to the question of where your money should be going, there is one factor that will have more influence over the answer than anything else — and that is how much money you have available.
In broad strokes, you either have a surplus or scarcity, or you don’t. Meaning that you are struggling with money, you are in an average situation, or you recently had a windfall — most people fit more or less into one of these three categories. And it is these categories that will help you determine how to invest what you have. I am going to focus more on surplus and scarcity, as there are already a wealth of articles on personal finance for those in average situations.
There are fewer people in this category than either of the other two, for apparent reasons. Not everyone has the luxury of a surplus of cash. Whether you won the lottery, inherited money, save a large sum while serving in the military or anything else, having a large sum of money to work with puts you at an advantage, but also brings new challenges.
Cash is best used for emergency situations or short-term spending needs, such as groceries, entertainment, and so forth. Financial planners generally agree that an ideal cash savings equals 12 months of your regular monthly expenses combined.
If you are sitting on more cash than that, you’re in a great position, but are sacrificing an enormous opportunity to grow your money. In the current market, you don’t want to throw all your money into stocks or other long-term investments at once because you will be more likely to lose more of it, but you should have a long-term investment strategy planned.
Michael Kitces, a commentator on the financial-planning industry, recommends that you move portions of your cash into the market a little at a time, over a period of three, six, or even 12 months.
Another word for scarcity is “debt.” They are both scary words, as anyone with a substantial amount of debt knows, and certainly words that introduce doubt about the future into your life.
No one will contest that investing for the future is an important part of managing your finances, but if you are drowning it debt, it doesn’t make sense to be regularly contributing the highest amount possible to your 401(k) every month. Instead, you should be trying to wipe out your debt as quickly as possible.
J.J. Montanaro, a certified financial planner, points out that “if you make an extra payment on a credit card balance that has a 15 percent interest rate, that’s equivalent to earning a guaranteed 15 percent return on your money — a promise the stock market can’t match.” In other words, the more quickly you pay off your debt, the more you’ll save in interest, and the more you’ll have to invest later.
Of course, if it’s possible, you should make contributions to your investments where you can, making sure that you have your priorities in line. Most families are saving for retirement and for a college fund for their children at the same time; if you are struggling with money, it is always a better idea to put the college fund savings on hold, as there are numerous ways to pay for college, and very few ways to pay for retirement.
In addition to rearranging your finances, you might want to start thinking creatively about how to generate more income, and not just cutting back on expenses. Renting out a room in your house or getting a second job are great ways to help pay your debt of more quickly, so that you can get back to investing in the future.
Guest post by: Mariana Ashley is a freelance writer who particularly enjoys writing about online colleges. She loves receiving reader feedback, which can be directed to email@example.com