How to Know If You're Ready to Invest in the Stock Market

June 26, 2021

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It almost seems like investing has become a national pastime during the pandemic. The meme stock craze captured our imagination this winter, and many people made a lot of money: Beginner investors who purchased shares of AMC and Gamestop were earning returns of at least 100% per share. And the rise of cryptocurrency has minted quite a few new millionaires.

With all this seemingly easy-to-get money floating around, you might think it's a good time to get in on the action. But how do you know if you're really ready to invest? And what should you be investing in?

"Investing a few dollars in crypto or the latest stocks is fine, but draw the line there," says Ryan McPherson, a Certified Financial Planner and director of coaching and education at Smartpath. "Novice investors need to first learn how investing and the markets work." 

Ivory Johnson, a Certified Financial Planner and founder of Delancey Wealth Management, agrees, adding that while investing in individual stocks or crypto may look promising, they can come with huge risks, such as sharp drops in value.

Even if you have some understanding of how investing works, and you're eager to drop some serious cash, hold on. Sure, investing is an integral part of your overall financial health, but you may not be ready for that step just yet. While everyone's financial situation is different, there are a few telltale signs that someone is not ready to start investing. 

1. You haven't thought about your priorities

When you're setting up a financial plan, take time to think through your life goals, the milestones you want to achieve and your priorities. Otherwise, you could find that your money is being used in a way that doesn't align with what you're striving for. Sure, you can earn great returns on investments, but it's of no use if you can't access it and use it for what you need.

Before opening a brokerage account, take some time to list out your goals and rank them in the order of importance. Johnson suggests looking at ones such as retirement, paying for your child's college education, leaving an estate to your heirs and any short or long-term considerations.

"Listing your goals in order of importance will help you clarify what your goals really are," says Johnson.

Once you've determined your goals, McPherson recommends looking at your timeline. As in, what do you want to do with your money and when do you need it? If you need the money within a few years, like for a down payment on a house, you'll need to invest differently than if you don't need the money until retirement age

Then you should consider your risk tolerance — i.e. your ability to stay calm when it comes to seeing dips in the market or your investments. Your risk tolerance will help inform the types of accounts that are best suited for you. 

"Ask yourself, at what point will a drop in your investments make you feel so uncomfortable that you'll want to make a change in how you're invested?" McPherson suggests. 

Thinking through your priorities, timeline of when you want to achieve your goals and risk tolerance will get you ready to start researching the best types of investments and brokerage accounts to open. 

2. You have a lot of high-interest debt

Being in debt isn't necessarily a big deal, especially if that debt is a mortgage with a low interest rate. However, if you're paying down high-interest credit card debt or personal loans, you may want to hold off investing. 

"Investing in this situation is a red flag because it suggests [someone is] investing for the short term, which is another way of describing the act of speculation," Johnson says. "Even if their gamble pays off, the history [of their financial behavior] suggests they'll cash in the investment before they benefit from compounding interest."

You can earn some great returns by investing in the market, but they'll be negated by the interest you're paying on your debt. Let's say you're earning an average of 7% in returns on your investments, but you're paying 18% in credit card interest. The 7% you're earning won't make up the fact that you're paying almost three times that amount in interest.

Instead, it's generally better to focus on paying down the high-interest debt as quickly as possible. Then you can use some of the money that previously went toward those debt payments to invest. 

Pay off high-interest debt faster

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If you decide to go the balance-transfer route, make sure you have a clear debt payoff plan, so you don't get stuck paying high interest rates once the intro period ends.

3. You don't have an emergency fund

An emergency fund or a buffer savings account comes in handy when unexpected circumstances arise. If you need to pay for a car repair, having the cash on hand is especially useful so you don't risk running into credit card debt. Plus, if the Covid-19 pandemic has taught us anything, it's that having money to pay for necessary expenses is essential, especially as millions lost their jobs and struggled to find work for many months. 

Think about it: What will you do if your money is stuck in an investment account and you need to buy groceries for the week?

Johnson suggests saving up three months worth of expenses, ideally in a separate savings account. If that feels like too much, he suggests aiming to save one month to start, then expand that goal to save more. 

McPherson adds that someone with a steady income will have different savings needs that someone who is self-employed. 

"I recommend three months of living expenses if they have a secure job and six months for self-employed or those with less job security," he says. 

4. You haven't done enough research

While all the media coverage makes it seem like many investors have earned high returns on their investments from crypto or meme stocks, the reality is many also lost money as values plummeted over time. Doing your research will help you understand the types of risks involved in investing, so you can be better prepared before you get started. 

You may not be able to prevent your investments from losing value. However, you can avoid paying high fees on investment products, which eat into earnings over time. You also want to make sure you understand the types of investments best suited for your financial goals.

"There's no shortage of available research," Johnson says. "In fact, it's likely available at any online or discount brokerages."

Aside from brokerages, there are a number of good books that teach the basics of investing. Some suggestions include The Little Book of Common Sense Investing, Broke Millennial Takes On Investing: A Beginner's Guide to Leveling Up Your Money and A Random Walk Down Wall Street.

You can also consider reaching out to a fiduciary financial advisor for assistance. These types of professionals are legally obligated to look out for your best interest — you won't be sold investments solely based on the highest commissions.

You can start your search by asking for recommendations from people you trust or by conducting a search at the Financial Planning Association's PlannerSearch©Garrett Planning Network, National Association of Personal Financial Advisors (NAPFA) or Paladin Registry.

If you're going the DIY route, start by learning basic investing terminology like expense ratios, management fees, dividends and volatility. Plus, do your research so you understand the different types of investment vehicles such as stocks, bonds, mutual funds and exchange traded funds (ETFs). 

For instance, while mutual funds and ETFs aren't necessarily as sexy as investing in individual stocks, they're less risky. That's because both are composed of a basket of securities — the ETF or mutual fund provider owns the underlying stock or bond, and you, the investor, can purchase a share of that basket. All this to say, you're investing in a variety of stocks and bonds, diversifying your investment portfolio. In many cases, mutual funds have higher fees than ETFs — here's where research comes in handy.

For those who are interested in more advanced strategies, many brokerages allow you to open a stock market simulator account, so you can trade with a set amount of play money to learn the ropes. 

5. You aren't investing in your 401(k)

Getting ready to invest

Investing offers plenty of benefits such as earning higher returns than high-yield savings accounts and offering you the opportunity to reach financial goals such as buying a house or enjoying a comfortable retirement. For those who have a lot of high-interest debt, don't have a savings buffer and aren't clear about their priorities, waiting to invest might be the better choice. 

If you decide it's not a good idea for now, you can still take proactive steps to prepare yourself to invest in the future. That can include making a more aggressive debt repayment plan, setting up automatic contributions to a dedicated savings account and reading books on investing. That way, you're well armed with the knowledge and financial habits necessary to invest successfully — when you're ready. 

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.