6 steps for handling your debt and starting in the market
When you land your first gig, it can be hard to decide what to do with your finances. On one hand, you might be eager to pay off your debts quickly; on the other hand, investing might seem like an interesting possibility. After all, getting an early start on building a portfolio means you can take advantage of compounding. With compounding, you continually earn returns on your entire portfolio, which grows when the market goes up.
"Time in the markets is one of the most powerful tools you have in investing, particularly when you're young." says Ted Dimig, Head of Investments at You Invest at J.P. Morgan. With time on your side, you should be able to better handle market swings.
Still not sure if you should put your money toward student debt or invest it in the market?
Here are some ways you can figure out if investing makes sense for you:
1. Make sure you have a low interest rate on your student loans
Many student loans do not require payments until after graduation, but it's never too early to start doing your research to find out how your loan provider's rate compares to others. If you can find a lower rate, then you should consider refinancing. That's when a new provider pays off your loans to your old lender, and you get to enjoy a new, lower rate. Another trick is to set up automatic payments for your loans—many providers give you a discount for doing so.
But what does your student loan interest rate have to do with investing?
Well, having a lower interest rate means you will pay back less money over the total life of your loan—and who doesn't want that? Also, having lower rates on your debt means that it might make sense to invest because the potential returns you could earn on an investment might outweigh the interest you're paying. To put it simply: if the expected return rate on your investment is higher than the interest rate on your loan, investing could be right for you.
2. Once you've got low interest student loans, consider your other debt
Of course, student loans aren't the only types of debt that you may be carrying. Many of us are paying down other debts, like credit card balances or car payments. With that in mind, before you consider investing, make sure you pay down any high-interest debt.
To get a feeling for the impact of high interest debt, consider Sarah. She has a $100 charge on her credit card, which has a 16 percent interest rate. She is considering building an investment portfolio with a mix of stocks and bonds that is expected to return 6 percent over the long-term. Which way should she go?
If she puts that money in the market, her investments will grow to $106 by the end of the year. However, her credit card debt would increase to $116. This would leave Sarah with $10 more in debt than she is likely to gain on her investment.
It's simple math, but it's important to think through carefully so that you know if your debt will hold you back once you start investing.
3. Build your rainy day fund
Another critical step to take before you start investing is to start saving up a rainy day fund. That way, when you get hit with an unplanned car repair or apartment security deposit, you will have cash on hand that is easily accessible, doesn't require increasing your credit debt, and won't require you to liquidate any of your investments. As a rule of thumb, aim to have at least three to six months of living expenses set aside in a savings account.
4. Decide on your investing goals
Once you've got all of these bases covered, you're ready to consider investing. But make sure you know why you're investing before you start. Ask yourself questions like how do you plan to use the money you're investing? Is it for a down payment on a home? A dream vacation? Retirement? How soon will you need the money? How would you feel if you lost some of it?
These questions will help you figure out your risk tolerance—how much variability in the value of your money you're willing to withstand—so you know which investments to pick.
And remember, investing should be something you consider for the long term. If your goal is to invest so you can take a dream vacation six months from now, you might want to reconsider and put that money in a savings account instead.
5. Choose your investments
Investments fluctuate in value, and the peaks and dips can be a little nerve-wracking. To help protect yourself from huge market swings, begin to develop a diversified portfolio that has stocks, bonds, and other asset classes. Diversification can help protect you in the long run, since it's unlikely that all the sectors of your portfolio would decline in value at the same time.
How you choose to diversify depends on your risk tolerance and how active you want to be as an investor. Building your portfolio with hand-picked stocks can be risky because it requires ongoing monitoring and can make building a diversified mix of investments more difficult. On the other hand, investing in index funds, which hold all of the stocks or bonds on an index of a given market, can help to spread your risk more effectively.
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6. Keep up the momentum
One of the helpful tips in investing is doing it on a regular basis—and the easiest way to do that is to set up a continuous or periodic investment plan using an automatic monthly transfer from your main account into your investment account.
Thinking through these steps requires a little bit of upfront work. But once you evaluate where you stand and where you want to get, you'll be able to lay the groundwork to achieve your financial goals down the road.
The information within this document is being provided for informational and educational purposes only. It is not intended to provide specific advice or recommendations for any individual. You should carefully consider your needs and objectives before making any decisions. For specific guidance on how this information should be applied to your situation, you should consult the appropriate financial professional.
Investing involves market risk including the possible loss of the principal amount invested. Asset allocation/diversification does not guarantee a profit or protect against a loss. JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.
Any type of continuous or periodic investment plan does not guarantee a profit or protect against a loss. Since such a plan involves continuous investment in securities regardless of fluctuating price levels of such securities, you should consider your financial ability to continue your purchases through periods of low price level.
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