The 13 Steps to Investing Foolishly
Step 2: Settle Your Personal Finances

You have a few bucks set aside, you've just canceled your subscription to WiseMoney, you've stopped watching the "Cable News Wisdom Channel," and you're thinking of starting to get a little bit Foolish with your dough. Maybe you've registered (for FREE!) at The Motley Fool website, and you've been coming back regularly to some of our Foolish discussion boards. In fact, you've even peeked ahead a few steps to read about choosing a broker to make your first purchase of stock...

Hey! Whoa there!

Not so fast, buddy -- what's your rush? We know you're on the information superhighway and all, but believe us, when it comes to investing money you've worked hard to earn, you want to obey all the speed limits. Your personal finances need to be in squeaky clean order before you ever think of placing that exciting first stock trade. As you'll find Fools imploring again and again all over this site, do not ever rush. This Second Step is here to tell you to settle your personal finances.

Erase Credit Card Debt

First stop... how thick is your billfold these days? Is it full of cash or credit cards? One of the critical keys to investing is only to use money that is free of other obligations. Thus, if you are carrying a revolving balance on your credit cards, it ain't free! (Neither are you, unfortunately.) Here's why: Many credit cards have an annual interest rate of 16%-21%.
Let's say you have $5000 to invest, but you also have $5000 in credit card debt with an average annual interest rate of 18%. If you invest the $5000 instead of using it to pay off the credit card, you will have to get an 18% return on your investment after taxes (or about 24% before taxes) just to break even.

Credit card debt remains probably the single best answer we know to the question, "Why can't I ever seem to get ahead?" As of this writing, there are more than a billion credit cards in circulation in the United States... that's almost four cards for every American man, woman, and child. And nearly 70% of all credit card holders in the U.S. today carry a revolving card balance each month (i.e., they are paying the minimum amount due). Yikes! Most unFoolish, dear reader. With an annual interest rate of 18%, making minimum payments (2% of the balance or $10, whichever is greater) on just a $1000 balance is going to take you a little over 19 years to pay off -- during which time you will pay close to $1900 in interest on that $1000! It's enough to want to get into the credit card issuing business, isn't it?

As you now chart your path to becoming a more Foolish investor, we simply will not let you pass on to Step Three until you stop letting the credit card companies feed on you. Find out the details on how to pay down your debt, or discuss your credit card questions with other Fools.

A Plan for Regular Saving

Next stop... how well are you regularly paying yourself? In other words, are you routinely setting aside an adequate established percentage of your paycheck every payday? Or do you only set aside money when there is something left over? Or worse, are you finding there is nothing left to pay yourself with?
If you answered yes to either of the last two questions, you're simply not ready to pass Go yet. It's time to examine why you aren't paying -- or can't pay -- yourself. A Fool does not go investing with her lunch money, or next month's rent, or with money that should go toward paying off a credit card. We invest money that we have worked for (or received as a gift -- that counts, too) and have Foolishly saved. As stated above, only invest money that is free of other obligations.

Fools try to save around 10% of their annual incomes. For some, it'll be closer to 5%. Others might manage to put away 15%... for instance, those who are soaring in the National Basketball Association. The important thing is to establish a regular "rhythm" of savings and stick to it, even if that means living below your means. You should also have around three to six months worth of living expenses in an account that is liquid (like a money market account) for those rainy-day emergencies.

Now, if you already are routinely saving, are you exploiting all the possibilities you have to make that money grow tax-deferred -- i.e., through an IRA, or SEP, or Keogh, or 401(k), or 403(b) plan? Money in tax-deferred retirement plans can grow exponentially compared to money in a regular investment account, because you don't pay taxes on the money deposited or the earnings until you begin to withdraw it. Further, a number of employers now offer to match your 401(k) plan savings with additional monies kicked in to benefit you (read: free money!). Make certain you are plowing as much of your savings as possible into these highly Foolish vehicles. Remember: Pay yourself first, and you'll thank yourself later.

Learn More About the Rest of Your Personal Finances

Before you leap headlong into that dramatic first investment, you should at least give some additional thought to other aspects of your financial life, such as any investing for your kids, insurance, housing, your bank, and your wheels.

Come on over to the various "Managing Your Finances" discussion boards and meet thousands of other readers who are there to share their experiences and answer one another's questions.

Next Step: Setting Expectations »

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