Once you become aware of how much money can be made in the stock market, you may reasonably be itching to jump in. Don't do so until you're really ready to do so, though.
Here are three signs that you're ready to take on stock market investing. See how many of them you can check off and how many you may need to work on.
1. You've read up on investing
First, you should have read up some on investing before actually buying shares. Read enough to understand, for example, that shares of stock in public companies are actual ownership stakes in real businesses, not lottery tickets. Read enough to know that there are lots of ways to go about investing, some of which can be combined. For example, you may want to mainly be a value investor, like Warren Buffett, seeking undervalued companies with a margin of safety. Also read up to learn about classic investor mistakes (such as trying to time the market or taking on too much risk) -- so that you can avoid making them.
Your reading may convince you that simple, low-cost index funds are the best path to long-term wealth building. Here's how much you might amass over time with index funds, if they deliver an average annual growth rate of 8% during your investing timeframe:
Growing at 8% for
$5,000 Invested Annually
$10,000 Invested Annually
$15,000 Invested Annually
2. You're out of debt
If you've done your reading and learning, you may think you're ready to invest, but hold on -- are you carrying a lot of high-interest-rate debt, such as that from credit cards? If so, you should pay that off before investing. That's because high-interest-rate debt may be costing you 15% to 25% or more per year, when your investments may only be growing at 8% or 12% per year. In such a situation, you can be losing ground from year to year, shrinking your net worth instead of growing it.
Imagine, for example, that you owe $40,000 and are being charged 20% annually on it. That's $8,000 per year going up in smoke -- just for interest payments. Pay off that debt -- it may not be easy, but it can be done, and many people have done it.
3. You have a well-stocked emergency fund
Finally, be sure that you have established an emergency fund with at least a few months' worth of living expenses -- all non-negotiable living expenses, such as housing, food, transportation, taxes, utilities, insurance, and so on. You want to be able to survive an unexpected job loss or costly health setback or even an expensive car repair without having to take on debt or fall behind on mortgage payments.
It's easy to assume that you won't lose your job or that you won't suffer an injury resulting in a surprising $12,000 bill from a hospital -- but such things happen all the time, and usually to people who were not expecting them.
Once you've read up on investing, and the only debt you're shouldering is low-interest debt (such as from your mortgage or a car loan), and you have an emergency fund available to you... you're ready to jump into the stock market. Don't think that this means you can stop learning, though: The more you learn, the better your portfolio will likely perform and the more money you'll likely make. For the best results, expect to keep learning throughout your investing life.
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