Whenever I’m at a party with strangers, the inevitable “What do you do for a living?” question comes up. When I say I’m a financial advisor (or financial planner), the next question is always “What’s a good stock I should buy?” Or, “Do you like Tesla and Netflix stock?”
These questions are great, but I’m not in the stock tip business. Instead, I like asking my new acquaintances some personal finance questions to see if it even makes sense for them to invest in individual stocks.
Stock Trading Definition
To avoid confusion, I should first explain what I mean by “stock trading.”
Stock trading is when you are actively buying and selling individual stock shares through online brokerage firms such as TD Ameritrade, Charles Schwab, E-Trade, or newcomer Robinhood.
An example would be purchasing shares in Apple, Amazon, Tesla, or Walmart.
If you already are doing that or you are planning on doing that, then you should make sure you have these four financial questions taken care of.
1. Do You Have Credit Card Debt?
I can’t think of a worse kind of personal debt to have than credit card debt. According to NerdWallet, in 2017 that average APR on a credit card was 14.78%!
That means that your stock trading account should have an average return of over 15% after trading commissions for you even to consider trading stocks vs. paying off your debt.
You should do everything in your power to pay off your credit card debt! Many clients I work with could free up anywhere from $500 to $2,500 a month in cash flow by paying down credit card debt.
2. Do You Have Student Loan Debt?
This question is a lot more complicated than the credit card issue due to the various payback and forgiveness options for student loans.
That said, if you have student loan debt, you should consider paying that back before you start trading stocks. According to The Economist, the average student loan debt balance in the United States is over $37,000!
While interest rates on student loans are usually less than on credit cards, it will take you a long time to get your stock trading account balance up to $37,000.
3. How Much Do You Have in Your Savings Account?
I’m huge on having a proper emergency fund. You should have 3–6 months of expenses stashed away in an online savings account that pays an interest rate above 1.5%.
This account should be used when you have financial emergencies. Like when you lose your job, your car breaks down, a pet has an expensive vet bill—whatever. Having a proper emergency fund will keep you out of credit card debt.
4. Are You Saving for Retirement?
You should be putting money away into retirement accounts. It really doesn’t matter what type of retirement account you are using, but if you have earned income, you need to be saving money into a retirement account.
These are the types of accounts you should be using: 401(k), Roth 401(k), 403b, IRA, SEP-IRA, or Roth IRA. Do some research on which account is best for you, or hire a financial planner (like me) to tell you how much to put away.
Once you have found out the best type of retirement account, you should contribute 10 to 20% of your gross income per year. So if your salary is $100,000, then you need to be putting away $10,000 to $20,000 a year.
That money should be invested in passive mutual funds or ETFs. My favorite types of funds for retirement savers are target-date retirement funds by Vanguard, Fidelity, or Dimensional Fund Advisors. Pick the fund with the retirement year that closely matches when you think you will retire.
Full disclosure: My 401(k) is invested in the Dimensional 2055 Target Retirement Fund (DRIKX). I chose this fund because I like Dimensional’s investment philosophy and because the date of the fund is close to my target retirement year.
Bonus: If you have kids or your goal is to one day purchase a house, you should probably read these two posts before you start trading stocks:
- Financial Checklist for New Parents: How to Safeguard Your Child’s Future
- How to Buy Your First Home
Once you have all four areas above taken care of, it is probably safe to start investing a small portion of your overall net worth in the stock market. I’m talking like 5 to 10%.
Don’t go crazy investing more than that since chances are you are not the next Warren Buffett or Peter Lynch!