In a previous Budget Basics post we discussed the reason why you should pay off debt first and invest later. In summary, it came down to having the available money to zero out your debt, even though you wanted to invest in the future. For this installment we discuss the reasons why you should invest. Okay, you’re confused, so let us clarify.
The path toward financial security goes in steps, each one getting smaller as you move ahead. The first step, creating an emergency fund of $1,000, is probably one of the largest steps to take. The next one is to pay off your debts; however, this set of stairs gets progressively smaller as the money from each paid off debt goes toward the next one. The third step is to have a three to six month emergency fund set up.
At the point this is completed the next step to take is to return to investing. Why not during the build up of the emergency fund? Well, you want to have as much available cash on hand to populate this account as quick as possible. Again, it goes back to the point we made concerning debt payoff vs. investing. The more money available, the quicker you can finish the one step and move on to the other.
The next question to come up is what to invest in. Let’s take two things off the table — individual stocks and CDs. As of this writing, the rate of return on Certificates of Deposit are so low due to minimal interest rates that it isn’t worth placing your money in them. As for stocks — they can go up considerably, but they can also go down even faster. What you want to invest in are products which bundle numerous investments together to provide the best security.
For those who work for a corporation, the 401(k) is the best place to do this. Not only can you set a maximum amount to contribute but you can also choose the investment options. This depends on age. Younger folks may choose medium and higher risk bundles while those closer to retirement can opt for a lower risk plan. In addition, many companies match a certain percentage of contribution, and this gives the employee an extra benefit.
For those who can’t or don’t want to invest in a 401(k) plan there are the standard and Roth IRA options. The main difference between the two programs is one is full of taxable income (standard IRA) while the other is not (Roth IRA). Many people tend to roll over their 401(k) plans into Roth IRAs when they leave their job.
In the end, investment is key to building a post-debt income which flourishes each year and provides the potential of becoming a millionaire long before retirement.