The financial walk of shame is when you prematurely invest your money only to sell off investments shortly after for the extra cash.
Maybe you heard about a can’t miss investment from a friend, or you wanted to get a head start by investing early.
It's great to started as soon as you can. But the number one thing to have beforehand is a cash reserve.
This is just a savings account where you keep 3–12 months of your living expenses.
For some this may be $7,000, for others it may be $30,000 — the important part is having one (and knowing what yours should be).
Security & Peace of Mind
If you haven't had a fully-funded cash reserve before, you wouldn't believe the peace of mind you get once you know that you can live for several months without getting paid.
Those inconvenient problems that come up in life that require money to fix aren’t so stressful anymore.
It also opens you up to a new world of things to do with your money, like investing.
While there’s no one-size-fits-all financial advice, I’m a strong believer that you need to "earn" the right to invest - a concept I first heard coined by Douglas Boneparth.
Earning the right to invest means that you should have your financial foundations taken care of first, like understanding cash flow and establishing savings habits for example.
If you’re living paycheck to paycheck, there’s many things that I believe need taken care of before sending money to investments.
Selling off investments because you need the cash can impact you in a few different ways:
1. Overpaying Taxes
If you sell a stock that you’ve held for less than a year, you’ll incur short term capital gains tax.
Short term capital gains tax means that if you earned a profit, you owe taxes on that dollar amount at your ordinary income tax rate.
It sounds confusing but as an example: if you sold a stock you owned less than a year and you had $100 profit and you’re in the 22% tax bracket — you would owe ~$22 in short term capital gains taxes.
But if you were able to hold onto your investments for longer than a year, then you'd be subject to long-term capital gains rates which are much more favorable capping at 20%.
(There are many strategies around when to sell and which stocks to sell to offset capital gains but for simplicity, I’ll leave it there)
2. You may start to develop a negative view towards the stock market
With everything that's happened over the past couple of years, many people have rushed into the stock market trying to make quick money.
And that’s not necessarily a bad thing. But it needs to be viewed as what it is.
It’s trading, not investing.
You need to figure out if you’re investing for retirement or trading for income when entering the market.
It's possible hop on trends and make some money. But without knowing when to sell and how to make decisions after you’ve had some success, it can be wiped away quick.
Rather than viewing it as a place to let your money grow long term — if you're forced to sell investments prematurely, you may start to see it as a savings account that might go up or down, you never really know.
In my opinion, this is a harmful approach to the stock market. In reality, it should be viewed as a long-term growth machine, not a short term slot machine:
3. You may miss out on the growth of the stock market
If you’re forced to sell off investments early, you may miss out on almost all of the growth that can be experienced in the stock market.
Nobody knows when the market is going to go up or down but historically, it’s always trended up.
It usually pays to stay invested through the ups and downs if you have long term goals.
In fact by trying to time the market, if you miss out on just the five best days of the stock market, your returns drop by 35%.
Before you start saving for other goals or investing, it’s generally recommended to at least partially fund your cash reserve first.
This will depend on your comfortability, but I'd shoot for 2-4 months of expenses.
After what we experienced in 2020, some may argue 12 months is more accurate.
Either way, don’t worry if it takes some time to work your way up to it.
As long as you’re saving consistently, you’ll get there.
This will help cover any unexpected expenses that come up and will help avoid prematurely selling investments due to lack of cash.
This ties directly into the previous step. After you’ve determined how much you need in your emergency fund, you can begin to work backwards and figure out how much you need to save each month to reach that goal.
For example if your monthly expenses are $1,500 and you want a 6 month emergency fund, you’ll need to have $9,000 saved. If you’re able to save $500 month - you’ll reach your emergency fund goals in 18 months.
The important part is setting a realistic amount that you can save each month. Then, one way I make sure I save the appropriate amount is by automating the transfer within my banking app.
Before you begin investing, ask yourself why you’re entering the stock market.
Are you looking to make quick income?
Are you investing for retirement?
Having a clear understanding will help you set expectations for performance.
If you’re investing for retirement, you know that the day to day ups and downs in the markets won’t affect your long term growth. Generally when investing for retirement, you’re not going to see those weeks where your portfolio is up 250%+ like someone who was investing in Gamestop and others. If you’re trading for quick income, you may need to pay more attention to the market and you also have a chance to experience big gains.
But with the opportunity for big gains, you also have the other side of the equation — big losses.
Understanding your purpose for investing will help create clarity around your decisions to buy and sell.
Prematurely selling off your investments is a tough pill to swallow.
You worked up the courage to get started investing only to end back up in the same place.
A way to avoid this is to have an investment strategy.
A well-planned investment strategy can be one of the most profitable things you create in your life.
Don’t wait til it’s too late (or start before it’s too early).
Have you taken the financial walk of shame before?