Author: Brent Lemieux CFA® CPA
Like the answer to so many other questions, it depends. In order to determine how the money should be invested, and if it should be invested, we need to ask ourselves three main questions:
- What am I saving for?
- What does my debt situation look like?
- Do I have an adequate “safety net”?
What am I saving for?
Before investing, it is important to clarify your goals. How and when you plan on spending the money can make a huge difference in how it should be invested. If you have some cash that you plan on using for a down payment on a house in two years, we recommend investing that money primarily in safe, fixed income assets. However, if you are saving for retirement, you have quite a bit more time to recover from a market downturn. Because of this, your portfolio may contain a much higher proportion of diversified equities. Of course, it’s entirely possible to save for these two goals at the same time.
What does my debt situation look like?
It may be worth considering paying off any debt before investing. This decision depends on a number of factors, including:
- The interest rate. How much are you paying to service the debt? If this number is high, it’s probably best to pay off the debt first. See this post for a more in depth discussion.
- Your rate of return on investments. What can you reliably earn on your investments? If this number is higher than the interest rate, it may make since to invest and pay off the debt simultaneously.
- 401(k) matches. If your employer matches your 401(k) contributions up to a certain level, it may be wise to contribute up to that level to avoid leaving money on the table.
Do I have an adequate “safety net”?
Whether you begin saving and investing for a goal, or paying off debt, we always recommend starting with a cash reserve. A cash reserve protects you from financial hardship in the event that you lose your job or incur a large expense. A typical rule of thumb is to hold six months’ worth of essential expenses in a cash savings account. However, depending on the stability of your job, this number may be different for you.
If you’re interested in advice specifically tailored to your situation, contact us today!
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