The Basics — Do This Before Investing Your Money

Investment is not the first step. It is the tenth.

What to do before you start investing your money.

What are the basic things you need to take care of before investing your money? We will explore this topic in detail here so you can avoid jumping into the world of investments unprepared for the surprises that life may throw at you.

This is the second post in my ‘In Pursuit of Financial Freedom’ series where we are exploring the world of investments together. With the end goal of achieving our financial goals and attaining financial freedom. If you have not read the first one, I highly recommend reading —

Why Is Investing Your Money Necessary?

Now that we have established that investing your money is necessary, there are a few things that we need to cover before we do that. These should not be treated as optional but more a prerequisite for starting your investments. Again, this is my opinion based on my experience and you might feel otherwise. And you are entitled to feel that way. But hear me out before you make a decision.

PS — Most of the examples I have given are in the Indian context but the principles are universal and will benefit everyone.

1. Term Insurance

I relate with the quote — “Hope for the best. Prepare for the worst.” That is one of the best pieces of advice you can give anyone under any circumstance. That is exactly what we need to do with our finances too. I hope that you will live long enough so you can enjoy the fruits of your investments but prepare for the worst so your family’s future is secured even if you are not around to see it.

The current Term insurance penetration in India is very low. As per this article by ET, only 1 in 3 Urban Indians has a term insurance plan. The penetration in rural India is worse. Thankfully, the numbers seem to be on a constant rise. Still, they are very bleak.

If you are in your 20s or 30s, term insurance is exceptionally cheap. But whatever age you might be in now, please get one before investing. While there is no standard as to how much should the insurance cover be. The formula I use to calculate this is your current earnings per annum * the number of years you have to retire.

So, say you earn 20 lakh rupees per year, you are currently 30 years old and you plan to retire at the age of 55 (25 years from now). In this case, you should have a cover of 20 * 25 = 5 Crore Rs. Now, this may sound exorbitant, but you should at the very least strive for 10 times your annual salary at the minimum.

There are some common mistakes I see people making while getting a term plan that you need to be aware of –

1. Treating insurance as an investment — I made this mistake. I got into the trap that my investment policy would also give me a return after a few years. It was the worst mistake financially. And what was worse was that it took me 7 years to figure that out before I finally closed that policy.
2. Relying on your employer for term insurance — Please don’t do this and get an independent term plan.

Driving race cars is risky, not having life insurance is riskier. — Danica Patrick

2. Health Insurance

I don’t need to explain the benefits of Health Insurance but if you are still unsure check out this link. We went through a pandemic recently and many people either went broke due to medical costs or were just not able to afford the costs at all. This is a scary situation. And it could happen to any of us or our family members, at any point in our life. Pandemic or not.

Getting health insurance is a no-brainer.

Again, there is no standard as to how much health insurance coverage is enough. In my opinion, it should be between 50–100% of your annual income. And get a separate plan for your parents (your spouse and you can have a joint plan).

Some common mistakes that people make in this aspect and you should avoid –

1. Relying on your employer’s insurance plan — If you are a salaried individual, please, please get a separate health insurance plan outside of what your employer provides. There are 2 main reasons for this — The amount covered by the employer’s health insurance is generally very low and you can exhaust it very quickly. The most important reason is that when you retire or switch to a startup, you will suddenly find yourself without health coverage, and getting insurance at that stage is very tricky and very expensive.
2. Getting a very basic plan — Read the insurance fine print carefully as to what is covered and what is not. If you don’t understand this, you will find yourself in trouble when the time comes to claim the insurance.

Even if I might say to myself, ‘I don’t need health insurance. I won’t get sick,’ the fact is, as human beings with mortality, we are going to get sick, and it’s unpredictable when. — Neal Katyal

3. Emergency Corpus

Emergency Corpus is some money kept aside for emergencies. Life is unpredictable especially when it comes to an emergency. We should always have some money kept aside.

You could get fired from your job, a pandemic could shut your business, or there could be a health emergency in the family. It is just good sense to be prepared for anything that life throws at you.

Now, the question is, how much is enough? You can never know. But a good idea is to always have an emergency corpus of 3–6 months of your earnings.

By keeping the money aside, it doesn’t necessarily mean that you have to keep that as cash or in the bank. You could park it in liquid funds that allow you to take the money out within a few hours when needed. We will explore that option in future blog posts. But as a rule, before you invest your money, please have an emergency corpus.

4. Pay Off High-Interest Debts

If you have high-interest debt like a Student loan, a car loan, a personal loan, or a credit card debt, please pay them off before you invest any money.

The only exception to this should be a home loan which is usually cheap and very long term. All the other debts are bad for your finances and you should make a plan to pay it off sooner.

There are some arguments that you could invest the money instead of paying off the debt and earn higher returns. This is quite risky, especially if you are new to the world of investment.

A student loan can be in the 10–12% bracket, a car loan is usually 8–10% and a credit card interest rate can be as high as 35–40%. There is no guarantee that you will earn more than any of these interest rates in the short term. Home loans are cheap and in the range of 6–9%. They are also long-term. So there is a good chance that you will cover that up and earn profit over your debt. For everything else, just pay it off, please.

5. Define your financial goals

A lot of people just skip this step. But if you don’t, you will find yourself in a much better situation. Let me explain. But, before that, here are some of my short-term and long-term goals for reference –

1. Revamp home appliances worth 2 lakhs in 2 years
2. A vacation worth 3 lakh in 2024.
3. Pay off my home loan in 5 years.
4. Child education worth 50 lakhs in 15 years.
5. Retirement fund worth at least 5 Crore in 10 years.

A good financial goal has 3 components — The what, how much, and when. Once you have the goals, it is easy to run the numbers backward, do some calculations, and come up with a plan with also clarity if your goal is feasible with your current earnings or not.

Now, let’s take one of my goals — I want to have 50 lakhs for child education in the next 15 years. There are a thousand different ways to achieve this but I am going to consider mutual funds using the SIP route –

Goal - Child Education
Amount - 50,00,000 (50 lakhs)
Time - 15 years
Interest Rate - 12% (Speculative)

SIP details ->
Monthly amount - 10,000
Invested amount - 18,00,000 (over 15 years)
Returns - 32,45,760 (considering 12% return rate)
Total amount - 50,45,760

Do you see what we did there? 50 lakh rupees sounds like such a huge amount to save. But when you break it down into numbers with some speculative interest rate, you see that it is easy to achieve. 10,000 a month for the next 15 years doesn’t sound too bad, does it?

OK, now take a notebook, write down your investment goals, and get your calculators out. The numbers won’t scare you anymore.

6. Define a household budget

Before investing your money, it is important to understand your household budget. Calculate all your earnings, all expenses, and based on that you can define an investment plan.

In general, 20–40% of your income should go towards investment. This ratio varies depending on how much disposable income you have left after your expenses and that could be different for different people based on their age, responsibilities, etc.

One important exercise to do while budgeting is to differentiate between the ‘need’ and the ‘want’. Basic needs are easy to define and so are luxurious wants. Needless to say, spend on your needs and less on your wants.

The problem arises when something lies in the middle. But generally, my way to determine if that is a ‘need’ or a ‘want’ is to sleep over it for a few days. If after 8–10 days (or more), you still feel that item is essential to you, categorize it as a need.

Do not save what is left after spending, but spend what is left after saving. — Warren Buffet

7. Understanding different investment types

In the next blog, I will share with you some of the types of investments. But, please don’t take my word for it. Or any other financial advisor for that matter (I am surely not one). Before investing your money you must understand the following –

1. Different investment options
2. Understanding your ‘risk tolerance’
3. Understanding what ‘asset allocation’ means.

We will explore some of these concepts in the blogs to come. Stay tuned.

Risk comes from not knowing what you’re doing — Warren Buffet

8. The Logistics before investing

Now that we have covered the basics of what to do before investing, it is time to take care of the logistics. First of all, you need to have a proper bank account with internet banking enabled. I use the following apps to manage my investments. I have no affiliations with any of them and you can opt for alternate services too.

1. A Demat account — This is an account that will hold your financial securities (equity or debt) in an electronic form. In short, if you want to invest in stocks, mutual funds, debt funds, bonds, etc — you will need a Demat account. Now there are a lot of DPs(Depository Participants) out there that offer you a Demat account (most of the banks offer this service too). But I would recommend not to use the bank Demat accounts. There are a lot of good third-party DPs. I use Zerodha which has been amazing for me and is very user-friendly. You can use my referral code to create an account if you don’t have it. I will also be using my Zerodha account to explain things in the blogs to come. Once you create the account, download the Kite, Coin, and Varsity apps from Zerodha and you are ready to dive in!
2. A Crypto wallet or a crypto trading exchange account — If you want to invest in cryptocurrency, there are a lot of different apps out there to help you with it. I have been using CoinSwitch for the past few months but I have been having second thoughts about their service. I also have a WazirX account but I am looking at other options and will keep you posted.
3. Other ancillary apps — I use the Smallcase app for some of my equity investments ( I plan to write a separate blog just for Smallcase, stay tuned). Google Pay is my go-to UPI solution. Since I have diverse investments in different places, I use Google Sheets to track all of them together.

Again, I am not affiliated with any of these companies/apps. I use them personally and can recommend them based on that. We will explore some of the apps as examples of investment ideas in the upcoming blogs.

9. Be Prepared

Now that you have done steps 1–8, the 9th and most important step is to be prepared. Investment is a long-term journey and you will see a lot of turbulence along the way. You will question if this is the right step or if you should have taken that other route.

The only way to weather the volatile journey is to be persistent, persevere, and be patient. Especially the first 5 years. If you are still invested after 5 years, you are in for a wonderful ride but if you give up before, you will lose the opportunity to be financially independent.

Conclusion

Once people understand the importance of investing, they are excited to jump on the bandwagon. But is important to not skip the ‘before investing’ step — the basics. This could seem easy to ignore but life is unpredictable and we have to be prepared for all the surprises to come. So, my recommendation? Please do not skip any of these steps before investing your money so you can sleep better at night.

Join us in this Pursuit of Financial Freedom. Let me know in the comments below if this blog post was useful for you and what you would like to know more in detail. In the next post of this series, we will explore the different types of investments. So, stay tuned.

Disclaimer: I am not a financial advisor. I have no affiliations with any financial institutes. All the opinions shared in this blog are mine only. I am sharing my personal financial experiences and the knowledge I have gained over the years.

Are you looking to join me on this journey to financial freedom? Do check out the publication and follow for more articles on this topic.

In Pursuit Of Financial Freedom

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