Before you invest: a step-by-step checklist for beginners

What should be in place before your first investment?#

Investing is the last step of a sequence, not the first. The SEC's guidance for new investors puts an emergency fund and paying down credit card debt right alongside its advice on funds^[1]. The checklist below follows that order. Work through it once, then revisit it whenever your situation changes.

1. 1

   Map your finances

   List what you own and what you owe, and track a month of income and spending.

2. 2

   Build an emergency fund

   Keep a cushion in an insured savings account before putting money at risk.

3. 3

   Pay down high-interest debt

   Credit card balances charging high rates usually come before investing.

4. 4

   Write down goals and dates

   Name each goal and how many years away it is.

5. 5

   Decide how much risk you can take

   Think about how you would react to a 20% fall in a bad year.

6. 6

   Understand the product and its costs

   Be able to explain how it makes money, how it can lose money and what it costs each year.

7. 7

   Check who is selling it

   Look up the firm or professional on FINRA BrokerCheck or Investor.gov.

8. 8

   Watch for red flags

   Walk away from promises of high returns with little or no risk.

How do you get a clear picture of your finances?#

Investor.gov's first step is to take an honest look at your entire financial situation: what you own and what you owe^[2]. List your assets (cash, savings, retirement accounts, a car) and your liabilities (credit cards, student loans, car loans). Subtract the liabilities from the assets and you have your net worth^[2].

Next, track income and spending. The SEC suggests writing down what you and your family earn and spend each month, with a category for savings and investing^[2]. If there is nothing left over, the first job is to cut spending, not to pick investments. Many people build the habit by paying themselves first, with an automatic transfer on payday^[2].

How big should your emergency fund be before you invest?#

An emergency fund is money set aside for surprises: a job loss, a car repair, a medical bill. The SEC suggests starting one in a savings account at a bank or credit union, with an automatic deposit each pay period^[1]. Its roadmap notes that some people keep up to six months of their income in savings so it will be there when they need it^[3].

The reason is practical. Investments can fall at exactly the wrong moment. Without a cushion, an emergency could force you to sell after a drop and lock in the loss. In the U.S., deposits at an FDIC-insured bank are covered up to $250,000 per depositor, per bank, per ownership category^[4]; rules differ by country.

Should you pay off debt before you start investing?#

Usually, for expensive debt. The SEC's roadmap points out that most credit cards charge high interest rates, as much as 18 percent or more, if you don't pay off the balance each month, and that few investment strategies pay off as well as, or with less risk than, paying off all high interest debt^[3]. Investor.gov says the same thing more bluntly: no investment will give you guaranteed returns to outweigh the high interest rate on a credit card^[5].

Low-rate debt, such as a fixed-rate mortgage, is a different decision, and people reasonably handle it in different ways. The point is to compare the certain cost of the debt with the uncertain return of the investment.

How do you set goals and decide how much risk to take?#

Investor.gov suggests listing your most important goals first and deciding how many years you have to meet each one, because you need an option that fits that time frame^[6]. The SEC calls this your time horizon: the expected number of months, years or decades you will be investing for a goal^[7].

Then think about risk tolerance. Investor.gov frames it as whether you will be able to sleep at night if you buy an investment where you could lose your principal^[8]. A house deposit needed in two years and a retirement fund needed in 35 years should not be invested the same way. Read risk and return explained and risk tolerance and time horizon before choosing a mix.

How do you check the investment and the person selling it?#

Before buying, you should be able to say in plain words how the investment makes money, how it could lose money and what it costs. The SEC warns that it can be costly to ignore the fees for buying, owning and selling an investment^[9]. Ask directly how the professional gets paid; the SEC suggests that question and points to the firm's Form CRS relationship summary as a starting point^[10]. Our note on how investment fees affect returns shows what a 1% yearly fee does over 20 years.

Then check the person. The SEC says checking the background of an investment professional is easy and free^[9]. FINRA's BrokerCheck is a free tool for researching brokers, brokerage firms and investment adviser firms; its reports include recent employment history, registrations and licenses, and a disclosure section covering customer disputes and disciplinary events^[11]. The SEC also suggests looking up any professional on Investor.gov^[1].

What mistakes do beginners make?#

1. Investing the emergency fund

   Money for emergencies needs to be there on a bad day for markets. Keep it in insured savings, separate from long-term investments.

2. Investing while carrying card debt

   A balance charging 18% or more costs more, with more certainty, than most investments can be expected to earn. Clear it first where you can.

3. Skipping the background check

   Looking up a professional on BrokerCheck takes minutes and is free. Do it before the first meeting, not after a problem.

4. Buying because of urgency

   Pressure to decide today is a sales tactic. A sound investment will still be available after you have read the documents and checked the seller.