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All of us want to make money in stock markets. And given a chance, we would love to become Warren Buffet (lol) 🙂. But we believe that stock markets are inherently risky. And when dealing with risks, one should be cautious to start with. According to us, there are 3 very important things which should precede investments in stock markets –
Build an Emergency Fund
The goal of emergency fund is to have around 6 months of expenses in savings. This can be for more than 6 months too but minimum we suggest is 6 months. The emergency fund is not an investment. It is simply a pool of funds which can be dipped into in case of emergencies. One should not risk emergency funds to earn higher interests. This fund should be parked in only the most liquid of assets like Savings Account. Though this may seem like a lot of money being used to earn minuscule returns, the fact is that it helps in building personal financial security. If you decide to invest in stocks before having an emergency fund, you may have to sell your investments at a time when markets are down and you would then be forced to lose money.
Pay off high interest debt
Paying off high interest debt, especially those of personal loans and credit cards is a must. Many such debts have a 15% + rate of interest. And since it is nearly impossible to find a guaranteed return like that in stock market, it makes sense to pay off these high-interest-rate debts. (One can continue to have long term debts like home loans, etc even when entering the stock markets)
Understand yourself (& your risk appetite & investment time horizon)
Stock markets are not for everyone. If one is not comfortable with occasional rise and fall in portfolio value, then stocks can give sleepless nights. One should never invest more than one can afford to lose in the short term. Before investing even a rupee, one should understand that there are 2 type of risks associated with stock investing; namely company risk (possibility of company going down) and market risk (possibility of overall market going down). There is no way one can avoid these risks. But these can be reduced. And as they say, it is not about avoiding risk that matters, but how to manage the risk that is more important. Another must do for future investor is to figure out why they are investing? Answer to this question itself will give them a direction on where to start.
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