The Motley Fool

How much cash should you have before you invest?

In my experience, there are three kinds of self-destructive investing that afflict the average potential investor.

The first kind puts investing in the too hard basket and never gives it a second thought.

The second is the eternal procrastination. “Yeah, yeah I know investing is a good idea.” You’ll hear them say, “We’ll get around to it after our next trip to Bali” or “We’ve really got to get a new TV first, 65-inches just doesn’t cut it” or maybe “once we pay off the car”. You get the idea – it never happens, at least not before retirement is staring you down the barrel, at which point, it’s probably too late.

The third is perhaps the rarest, but it is someone who simply can’t wait to invest and throws every bit of spare change into shares at every given opportunity.

The reality is that all three of these paths lead to danger. The first is dangerous because (in my opinion) investing is vital to forge a comfortable retirement for an ageing population that has never lived longer. The second is dangerous because investing works best if you give it time and allow compound interest to do its work. The third is dangerous because if you plough all of your savings into shares and then you lose your job in a recession, you will be in a very dire situation trying to sell shares that have lost significant value.

So what to do?

In my view, there are two important steps to conquer before you should put your hard-earned dollars into investments for your future

First is getting the right attitude and understanding how important investing is. Putting it off or putting investing in the too-hard basket was ok in a world where everyone had a job for life and a guaranteed pension to match. But times have changed. And our investing attitudes need to change too.

Second, if you are ready to invest, make sure you can afford it. This may sound strange, but the first step of investing is putting in place financial safeguards to ensure that you have a solid foundation of cash that can weather unforeseen crises that might befall you. If you or someone in your family loses your job, gets sick, crashes a car or is befallen by any other unfortunate situation, you don’t want to have to rely on selling your investments prematurely (and at the wrong time).

Therefore, it is (in my view) prudent and necessary to have at least a few months worth of living expenses saved up in cash as a strong financial rock before you build your house of investments. After all, the houses built on rock stand strong in a storm. Don’t try to build on sand.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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