Having been sufficiently convinced that it is a great idea to start investing during graduate school, you’re eager to get your money working for you. But as beneficial as investing is for the long-term growth of your personal net worth, you must make sure that your finances are sufficiently prepared in the here and now. Once you can answer “Yes!” to the five questions below, you’re ready to start investing your stipend.
Do you have excess cash flow/cash savings available to invest?
Right off the bat, of course, you have to have some money to invest. It doesn’t have to be a lot of money by any means, but you must have either some cash flow available every month or savings that you are willing to devote to investing. If you are going to invest on a regular basis, write your investing goal into your budget and pay yourself first through an automated transfer. Investing a lump sum of cash savings at one time is a fine approach as well, though you must make sure that you still have enough cash on hand (more on that in question 3).
Do you have zero high-interest rate debt?
Even if you’re super gung-ho about investing and highly optimistic about your prospective long-term rate of return, it’s not the best idea to put money into investments while you have high interest rate debt. When you pay down debt, you receive a guaranteed “rate of return” on your payment that is equal to the interest rate of the debt. On the other hand, investing comes with a degree of risk and you are not guaranteed any specific return, especially in the short term. Given an interest rate on debt equal to or slightly less than the expected long-term rate of return on your investments, mathematically it makes more sense to pay down the debt.
Generally speaking, you should pay credit card debt down immediately and with gusto (even 0% introductory offers) before beginning to invest. Any car or personal loans that have a very low interest rate and subsidized student loans can take a back seat to investing if you like, though it’s also a great option to pay them off before beginning to invest if they weigh on your mind. Unsubsidized student loans can fall into either category. The interest rate tipping point above which you should pay off debt and below which you should invest is up to you and will be related to the long-term rate of return you expect on your investments.
Do you have sufficient short-term reserves?
It’s important to have some cash savings available to you before you begin to invest. Even though that money will not earn much of a return sitting in a checking, savings, or money market account, it serves as a safety net. You don’t want to have to go into debt or pull out the money you already invested if a short-term problem pops up. It’s much better to have cash available to smooth out any rough patches.
There are two forms of short-term reserves that you should build to a sufficient level before you begin to invest: an emergency fund and cash for short-term spending. Every grad student should have at minimum a $1,000 emergency fund and perhaps even a larger one before moving on to any other financial goals. The other type of cash to keep available to use is money to use for irregular expenses, which are expenses that occur once or a few times per year that are difficult for you to cash flow.
If you’re incredibly eager about investing, you can build these two types of cash funds to a fairly low funding level – perhaps just $1,000 in your emergency fund and $1,000 for short-term spending. But as you grow your investment accounts, consider continuing to build your cash reserves as well.
Do you have an investing goal?
Before you begin investing your stipend, you have to be very clear about what you are investing for. The most common investing goal for grad students is for retirement. It’s rather counter-intuitive, but you should actually start investing for your longest-term goal first. Some grad students may also create a mid-term goal for about 5 years out. The time horizon of your goal will determine your asset allocation (the level of risk you want to take for the amount of return you want to get). You should invest as aggressively as you are comfortable with for your retirement/long-term investments, but somewhat more conservatively for your mid-term investments.
For the specific goal of investing for retirement, you will need to decide whether to invest inside a tax-advantaged retirement account like an Individual Retirement Arrangement (IRA). If you decide to use an IRA, you will have the choice between a Roth IRA and a traditional IRA. In my experience, virtually all grad students choose the Roth IRA.
Do you know where and in what you will invest?
Your final decision before beginning to invest your stipend is what brokerage firm to invest through and what specific investments to put your money in. When you are deciding on a brokerage firm, look at their selection of investments, cost, reputation, and minimum balances. Passively investing in broad index funds is the most effective and time-efficient approach. You can learn all you need to about passive investing in as little as an hour or two, so don’t let yourself get bogged down in analysis paralysis. Getting started investing with a good but imperfect strategy is better than waiting around to develop a perfect strategy.
Once you have five ‘Yes’ answers to the questions above, don’t delay your first contribution to your investment account! You are well prepared to take the next step with your finances.
If your answer to one or more of these questions was ‘No,’ don’t despair. Put the energy and excitement you have toward investing into turning your ‘No’ into a ‘Yes.’ This might take as little as a couple hours of contemplation for the last two questions or as much as months or years of refining your budget and diverting your cash flow for the first three questions. But if you apply yourself diligently, you’ll be ready to start investing before you know it.
Are there any additional steps you with you had or hadn’t taken before starting to invest your stipend? What steps are you working on before you begin investing your stipend?