Two things to do before you put a penny in the stock market

published 6 July 2012

If you want to get your investing off to a successful start, there are two things to do first.

Have no short-term debt

Why? It's simple. You have to pay interest on debt. And you have to pay a lot of interest on short-term debt.

If you could borrow money at 7% from a bank for three years, and invest it for a guaranteed return of 12%, then it would make sense to take a loan and invest the money.

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But that's never going to happen. The interest you pay on short-term debt will always outstrip any return you can hope to make without taking a ludicrous amount of risk.

So investing (or even just putting money in the bank) while you still hold short-term debt is like using a thimble to fill a bucket with a hole in the bottom. A waste of effort.

Patch your financial leaks first. Then you can start saving.

Have three months' living costs to hand

That's why we have emergency funds. A pot of cash you can access immediately to cushion against life's ups and downs.

How big should your emergency fund be? It depends partly on your circumstances. If you have dependents, you're probably less keen to suffer a drop in living standards than if you're on your own.

As a minimum, aim to have three months of living costs saved up. In other words, you could live for three months at your current standard of living without earning anything.

Of course, three months go by fast. So it's not much of a cushion. Ideally, it would be six months.

But I can already hear some of you sighing with tedium at the idea of saving up three months' costs.

So once you've got three months, you can start investing. But keep topping up your emergency fund too until you get to six.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.