Am I ready to start investing? A four-step checklist

There can be significant advantages to investing your money rather than saving it in the bank. The returns can potentially be greater over time than cash and inflation. The amount you make on savings in a bank account often lags the rise in the cost in living which means your money won’t go as far.

However, there are circumstances when investing is not always the right thing to do. Sometimes there are more pressing needs for your money, or you might not want to take the risks that come with investing.

Here are four situations to work out if saving or investing is the right option:

1. Do I need to pay off a loan or debt?

Depending on what sort of debt you have, paying off any existing borrowings may be the first line of action before investing your money.

Certain loans, such as student loans, are given at such a low rate that you may be financially better off investing and paying them off as you go. This can vary based on when you graduated and what rates you pay.

Bank loans can be more expensive, as can interest rates on credit cards. It’s not uncommon to see rates above 30% on some loans or cards and these debts should really be cleared before you invest.

This could still mean that investing isn’t too far in your future. If you have £2,000 to pay off on your credit card and an interest rate of 20%, you could be debt-free in just over two years by setting a fixed payment of £100 per month.

2. Do I have an emergency fund?

Practically, many people choose to keep some amount of their money in savings to allow for summer holidays or an upcoming renovation. But another helpful savings pot to hold is an emergency fund. This is a separate pot that can cover expenses in case something goes wrong, whether that be losing a job or incurring an unexpected cost, like a car repair.

Usually, these funds are held in an easy access savings fund, so there are not additional barriers if you need to use it, and so you know exactly how much will be waiting for you. The age-old rule for emergency funds is saving for three to six months of expenses. This would include costs such as rent or mortgage payments, groceries, bills, and any debt payments.

You can create an estimate of these expenses by adding up monthly costs, or you can look at what you’ve spent in the last few months and create an average. Whether you lean more towards the six or three-months' worth of savings is a personal decision. This could rely on other factors such as if you have family you need to support, or if you could cut back on typical spending levels.

3. Do I need a specific amount of money in the next few years?

Whether you’re investing for a future home or retirement, it’s important to consider how long you expect your money to be in the market. Historically, the market has gone up over time. But downturns can happen, so you need to allow time for your investments to recover.

For example, if you are investing to pay for your child’s school fees in a year’s time, you don’t want to risk your money falling in value and leaving you short. In this situation, investing might not be right for you because of the short timeframe. But if your plans remain further in the future, there’s ample time for the market to shift around. In fact, you would expect volatility during this time.

Often, to reach your financial goals for something like getting on the property ladder, you may need to do some investing to help your money count for more. If you put £5,000 in a tracker fund that mirrored the MSCI World global stock index 10 years ago, you would have built up a pot of £12,900 excluding charges. Even if you were able to maintain an interest rate of 5% in a savings fund over this time (remember the Bank of England dropped interest rates to 0.1% during covid), you’d have a total of £8,144.

In this example, investing would have generated greater return than cash. Once you get to within a few years of needing to spend the money, one strategy would be to switch to lower risk investments such as a money market fund or switch into cash. That would help to lock in the gains and ensure you had enough to meet your goal.

4. Have I started putting money away for retirement?

In the first few years of your career, retirement savings can seem like a distant worry compared to saving for your home or getting your summer holiday booked in. But investing in these early stages is also when your money counts for the most.

If you are opted in to your workplace pension scheme, congratulations, you’ve started your investment journey, possibly without even knowing. But how much of a difference does it make to start investing at the start of your career, versus 10 years later?

In the UK, automatic pension enrolment starts when you’re 22. Let’s assume you are starting your career with a job earning £30,000 a month and are contributing 5% of your salary to your pension, adding up to £1,500 a year if you contribute before tax. On top of this, your employer will be required to pay in at least 3% of your salary, and the government will usually provide tax relief. That means in total, £2,400 is going into your pension per year.

Source: AJ Bell

In 10 years, if you have no salary raises but your pension returns an average 5% after charges annually, you will have accumulated £31,056. If you kept up that same investment, still with no raise, until you were 62 and ready to retire, you’d have £305,204. But what if you waited 10 years before you started to make contributions, effectively beginning your retirement savings journey at 32? You would have to near double the amount going into your pension each month to reach that same rate of savings at retirement at 62. One way to play catch-up is to increase contributions every time you get a pay rise or receive a bonus from work.

While a pension is an excellent start to your investment journey, it’s important to remember that your money could be locked away for a long time. If you require flexible access to your money sooner or want to invest for a specific purpose like a home or your child’s education, you may want to consider a vehicle like an ISA instead.