3 Things You Must Do Before Investing For Retirement

What are the 3 things you MUST do before investing for retirement?

First of all, it's making a mental shift. If you’re not as wealthy as you would like to be yet, it might be because you need to start looking at your finances in a different way. What time frame do you use when making financial decisions? Most wealthy people think LONG TERM. Not on a week to week basis, or a paycheck to paycheck basis.

I want you to start thinking long term. I want you to start making your financial decisions based on 5, 10 or 20 year time periods. I want you to start making decisions thinking about your net worth and where you want to be FINANCIALLY in 5, 10 or 20 years. That is how wealthy people think.

What is net worth you ask? Net worth is a very simple formula. It's essentially the result of adding up everything you own, subtracting what you owe and the result is your net worth.

Everything you own - everything you owe = your Net Worth.

If your net worth is positive right now, that's awesome! If you're a recent graduate from college or a graduate program and you have student loan debt, your net worth is probably negative & that's okay. You're just starting out.

If you're in your 50's and you still have a negative net worth, you’ve really got to shift your mentality right now to start thinking about increasing your net worth, okay?

The second thing is, you’ve got to get out of credit card debt at a minimum before you start investing. It makes no sense to keep paying 17% to 20% on credit card debt before you start investing for retirement, where you may earn an average of 7% to 12% year to year. That is not financially logical.

If you have to look at investing versus paying off your house, and your house is at a 4%, and you're looking at the stock market and the average for the last 20 years it's been doing, about 9.44%, or so. Yeah, it makes more sense to invest for retirement before you fully pay off your house.

It is good to find a balance because I do want your house paid off by retirement. Typically, 15% of your income to retirement then the rest to the house until it's paid off is a good plan.

High-interest debts need to be gone before you think about investing in a 401k or your Roth IRA.

The other thing I want you to think about is making sure you have a nice emergency fund of cash, or easily accessible funds that you can get to if you were to have an emergency.

Good places for this money are in a "high-yield" savings account (I put that is quotes because high-yield these days is <1%) or a money market fund that you can access quickly if you needed it but not IN your checking account where it might accidentally get spent on a wild night out.

It makes zero sense to be investing in your 401k and have $0 in a savings account. What's going to happen is, when you have an emergency, you're either going to put it on your credit card or you're going to raid your 401(k). If you raid your 401(k), you're not only going to pay your tax rate, say if it's 25%, you're also going to pay a 10% penalty.

That means you're going to pay 35% to get the money out to cover a small emergency or a small short-term job loss.

My recommendation is to have at least three months saved up for an emergency fund before you start investing for retirement. If you're living at home with your parents and you have no real expenses outside of basic living costs, at least one month of expenses saved before you get started. If you’re self-employed or a freelancer or have a highly variable income, then I recommend 6 months in your emergency fund.

Have some money saved up in cash. Put that aside. Do not touch that money, except for emergencies, before you start investing in your 401(k) or Roth IRA. This money is not an investment. It’s insurance. Insurance costs you money, but it protects you from tragedy.

If you're older and out on your own, you really need to have a few months of emergency money saved up. I know it's not common. 47% of people, according to a recent Federal Reserve Board survey, couldn't cover a $400 expense with cash if they had an emergency.

If you're here and you're reading this and you're listening to my advice, there's a good chance that you are above average, or at least you're going to be shortly if you follow it. THE REASON IS BECAUSE YOU HAVE MADE THE SMART DECISION TO EDUCATE YOURSELF IN THE AREA OF FINANCES AND SOONER RATHER THAN LATER WILL START MAKING SOME POSITIVE CHANGE IN YOUR FINANCES. Most people don’t think about their finances and drift from paycheck to paycheck without a plan. If you’re here, I have a strong feeling you’re not like this or you won’t be for long.

Make sure you have at least three months of expenses before you start investing in your 401k's or your Roth IRA's. This will keep small bumps and bruises from being tragedies. THESE LIFE EVENTS WILL NO LONGER DEFINE WHAT YOU CAN DO NEXT, KILL YOU FINANCIALLY, OR HAVE YOU PAY MASSIVE AMOUNTS OF PENALTIES AND TAXES BECAUSE YOU RAIDED YOUR INVESTMENT ACCOUNTS OR OPENED UP A NEW LINE OF CREDIT.

In summary, 3 of the things I recommend you consider before investing are:

1. Start thinking long-term about your finances and graduate from the paycheck mentality to making decisions based on longer timeframes and with regard to increasing your net worth.

2. Pay off ALL high-interest debt.

3. Save a hefty emergency fund, in cash, of at least 3-6 months before investing.

This post originally appeared on KIS Financial Planning.

About the Author: This post originally appeared on KIS Financial Planning. Jason Hamilton is the founder of KIS Financial Planning, a fee-only financial planning firm that caters to Gen X, Millennials, and Fortune 500 Sales & Management Professionals. You can learn more by connecting with Jason on LinkedIn.