With high inflation driving up the cost of just about everything while wages aren’t keeping up, investing may seem like a luxury you can do without until things stabilize. Unfortunately, this thought process can cause you to fall even further behind. After all, investing gives you the ability to let your money work for you, and over time, a strong portfolio can help cover the gap that your stagnant paycheck won’t fill.
This makes the investment more important now than it has been in a long time. After all, every dollar of unearned income you receive is a dollar you don’t have to cover with your salary. Add the composition The effect of your investments can increase over time, and a decent portfolio just might provide your best approach to combat the rampant cost pressures we all face.
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Start by controlling your costs
Of course, with your costs escalating, it can be difficult to find the money to invest in the first place. In this regard, there is a simple approach you can take to help you prepare for investing. Start by tracking your spending – every penny – for about two months. At this point there is no need to judge where your money is going, just write it down. In addition to this tracking, write down an estimate of regular costs you face that aren’t monthly, such as birthdays, vacations, and insurance.
Once you know where your money is going, look at those expenses and mark them in red, yellow, or green, depending on your own priorities. Money that you mindlessly spend or don’t want or need to spend otherwise, mark red. Money that goes to critical parts of your life that you can’t or won’t live without, mark green. Everything else, yellow mark.
For expenses coded red, the next step is simple: stop spending them. These are costs that you face and that are not a priority for you at all. As for green expenses, it’s good to keep them, as long as they don’t overload your income. Yet over time, you can look for ways to reduce them, such as paying off your mortgage to lower your housing costs.
To meet your yellow color costs, you have some work to do. These are things you spend money on that aren’t super critical to you, but you’re not quite willing or able to completely go without. For these costs you need to optimize. For example, you might want to switch from purchased coffee to the home-brewed variety, or even free coffee that might be available at your office. Likewise, a programmable thermostat can help you reduce your energy consumption without affecting your life.
Between reducing red expenses and optimizing your yellow expenses, you should be able to put some space between your income and your expenses. If not, go back to your expense list and see if there are any other yellow expenses you can code red, green expenses you can code yellow, or yellow expenses you can further optimize. Your goal here is to free up as much money as possible while minimizing the impact on the things you prioritize in your life.
Then settle your debts
Once you have your costs where you need them, your next goal should be to get your debts under control. The most effective approach to paying off debt is known as the debt avalanche method. To use it, start by aligning your debts from the highest interest rate to the lowest interest rate.
On all debts except the one bearing the highest interest, pay the minimums. On this highest interest debt, pay as much as you can above this minimum until it is fully paid off. Once this debt is paid off, take all the money you had paid and add it to your new debt at the highest interest rate. Repeat the process until almost all of your debts are paid off.
It may be good to keep some your debts out of the avalanche, paying only the minimum until they are paid off. For this to be true, the debt must have a low interest rate, a low payment, and serve a key purpose for your future. Debts that may do the trick are often mortgages, medical debts, or car loans on modest and reliable means of transportation.
Finally, start investing
By getting both your day-to-day expenses and your debts under control, you may find that you’ve freed up a lot more money to invest than you originally thought possible. Be sure to create a modest emergency fund, then get to work investing for the long-term future.
If you’ve never invested before, a low-cost general index fund is a great choice. You’ll get market-like returns with very little effort. Plus, you’re likely to outperform the vast majority of Wall Street’s best and brightest active fund managers over time. Once you get there, you’ll be at the point where your money can work for you – and help you fight the crazy inflation we all face.
The sooner you embark on this approach, the sooner you can have a powerful tool at your side that can help you deal with ever-increasing costs. Make today the day you start your journey and give yourself every chance you can to reach the point where the return on your money can cover a good portion of your costs.
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Chuck Saletta has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.