So, you’ve decided to start investing.
It’s a great move and a risky one too. It might surprise you to learn that a $10,000 investment in the S&P 500 index 30 years ago would be worth nearly $1 million today.
Stock investing, if done right, can be a very lucrative venture. But, if done wrong, it can leave you in a tremendous amount of debt that you have no chance of paying off. So, before you start investing, it’s good to be sure you’re prepared—both financially and emotionally.
Ready to dive into the world of investing? Here are important things you should know before you start investing.
1. A Cash Investment Fund Can Save the Day
Life sometimes can mess with your investment plans in ways you never saw coming. For example, you might have a “recession-proof” investment plan, but what happens if you lose your job? What if your car breaks down? What if you fall prey to identity theft?
In such situations, most people usually turn to credit cards. But credit cards aren’t always the best solution. For instance, your bank can cancel the cards if you’re a victim of identity theft.
With that in mind, it’s advisable to have a healthy cash emergency fund stored away somewhere in your savings. A cash emergency fund can save the day should things go south and ensure your financial struggles don’t mess up your investment plans.
2. Investing Reckless can Ruin Your Future
New investors must know that the stock market doesn’t operate like a casino where you’re supposed to gamble your money.
Maybe you read on Twitter about how a few investors made a fortune through short selling. However, as a new investor, you should hold your horses until you’ve learned the ropes of this seemingly lucrative investment strategy—lest you end up caught in a short squeeze.
A short squeeze occurs when many investors short a stock hoping its price will go down, only to shoot up instead.
When this happens, the short seller is at risk of losing a large sum of money. As a result, short-sellers scramble to close out their positions as quickly as possible to minimize the losses, thus creating a short squeeze—a temporary spike in share price.
Short squeezes in history have left many investors bankrupt, with some renowned figures committing suicide after incurring massive losses. So to stay on the safer side, always be cautious when investing.
3. The Money You Earn Will be Subject to Tax
Investing is one of the best ways to beat inflation. But that doesn’t keep you from the grip of the taxman. Taxes can and will greatly affect your investments.
When you cash in what you’ve earned through investments, you’ll be liable to pay capital gains tax. A capital gains tax is a kind of tax applied to the profits earned on the sale of an asset. Unlike other forms of taxes, capital gains tax is only paid once an asset is sold.
The amount of tax you’ll pay depends on the period for which you’ve been holding the asset. The longer the period, the higher the capital gains tax.
4. Know Your Risk Tolerance
Risk tolerance refers to the degree of variability in investment returns that you’re willing to withstand in your financial planning.
You should understand the level of risks you’re willing to accept in pursuit of your objectives. Moreover, this understanding should be realistic and time-bound. Because if you take excessive risks in investing to earn more, you might panic and end up selling at the wrong time.
That said, know that some investment assets have higher returns than others but come with higher risks. For example, mutual funds usually provide higher returns than fixed deposits but are also riskier. So you have to decide whether you have the stomach to tolerate the high risks associated with these financial instruments.
The Bottom Line
Investing is a great way to secure your financial future. However, it can also ruin your financial future if done recklessly. By following these investing basics, you’ll be better equipped to navigate the world of investing.