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The basics · Lesson 2 of 11

Before You Invest: A Cash Cushion and Costly Debt

See the two steps that come before investing: an emergency fund, then expensive debt. Learn how big a cushion to build and which debt to pay first.

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THE WRITTEN LESSONFollow along at your pace

Two things come before your first investment: cash for surprises, and a plan for expensive debt. Skipping them is the most common beginner mistake, because investing money you may need next week, or while a card charges you a high rate, works against you. This lesson shows you what to do first, and how much.

Why a cash cushion comes first

The first step is an emergency fundemergency fund: Money kept in an account you can reach quickly, to cover unexpected costs or a drop in income without borrowing. How much to hold depends on your circumstances, and official guidance differs by country.Full entry in the glossary. That is cash you set aside for things you did not plan for, like a car repair, a big bill or losing your income. Without it, a surprise cost often goes on a credit card, and a short shock turns into debt that lasts.

A blue credit card on the left and, beside it, a red line chart called Debt that lasts, climbing steadily over time.(opens the full-size picture)
Without a cushion, a surprise bill can become lasting debt.

Even a little helps

You do not need a big pile to feel a difference. In one US survey, about 79 percent of people with no savings had trouble paying a bill in the past year. With some savings, but less than a month’s income, it was 44 percent. With at least a month saved, it was only about 6 percent.

Three jars, empty, partly filled and fuller, above three bars showing who had trouble paying a bill in a US survey: about 79 percent with no savings, 44 percent with less than a month's income, and about 6 percent with a month or more.(opens the full-size picture)
The more you have saved, the fewer people struggled to pay a bill.

How big should it be?

A common guide is three to six months of your essential costs, such as rent, food, bills and getting to work. That can feel like a lot, so start smaller. A good first target is about one month of take-home pay. For example, if you take home 3,200 dollars a month, aim for 3,200 dollars first, and build up from there.

Six month boxes in a row. Month 1 holds banknotes and is labeled First target, $3,200, matching a take-home pay slip of $3,200. A bracket over months 3 to 6 says Later: 3 to 6 months of essentials. Below, essential costs: Rent, Food, Bills, Getting to work.(opens the full-size picture)
Start with one month, then build toward three to six months of essentials.

Where to keep it

Keep this money as cash, in a separate savings account you can reach quickly, at a bank covered by your country’s deposit protection scheme. Do not invest it. If prices fall just when you need the money, you would have to sell at a bad time.

Two cards. Savings account shows a jar of coins labeled Cash, with three checks: Separate, Quick to reach, Protected. Invested shows a chart rising and then falling after a flag that says Need the money!, labeled Sell at a bad time.(opens the full-size picture)
Emergency money belongs in cash you can reach, not in the market.

Step two: costly debt

The second step is expensive debt. Credit cards often charge 18 percent a year or more. Leave a 1,000 dollar balance for a year at 20 percent, and it grows to about 1,220 dollars. Virtually no investment reliably earns that much, so clearing the debt comes first.

A credit card labeled 18% or more a year, and a chart called Card balance rising from $1,000 to $1,220 over 12 months. A banner says No investment reliably earns this.(opens the full-size picture)
A card balance grows faster than investments can reliably earn.

Highest rate first

Pay off the most expensive debt first, and pay the minimum on everything else. Treat other loans at about 8 percent or more the same way. Never invest with money borrowed on a card. And if you cannot cover the minimum payments, get free debt advice first.

A list called My debts: Credit card at 24 percent, marked Pay off first; Loan at 12 percent, Minimum; Store card at 10 percent, Minimum. Below are three notes: About 8% or more: same rule, a crossed-out Invest with card money, and Can't pay the minimums? Free debt advice.(opens the full-size picture)
One debt gets the extra money. The rest get the minimum.

If there is little left each month

These two steps are the whole plan for now, and that is fine. A cushion and less expensive debt put you in a stronger position when you do start investing.

YOUR TURN

This is general education, not personal advice. For your own decisions, see a regulated adviser or a free debt advice service.

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Read the full lesson script

Before you put a single dollar into investments, two things come first. In this lesson, you'll see what they are, and why they matter so much.

The first is an emergency fund. That's cash you set aside for things you didn't plan for, like a car repair, a big bill, or losing your income. Without it, a surprise cost often goes on a credit card, and a short shock turns into debt that lasts.

Even a small cushion makes a real difference. In one US survey, about 79 percent of people with no savings had trouble paying a bill in the past year. With some savings, but less than a month's income, it was 44 percent. With at least a month saved, it was only about 6 percent.

So how much should you keep? A common guide is three to six months of your essential costs, like rent, food, bills and getting to work. That can feel like a lot, so start smaller. A good first target is about one month of take-home pay. For example, if you take home 3,200 dollars a month, aim for 3,200 dollars first, and build up from there.

Keep this money as cash, in a separate savings account you can reach quickly, at a bank covered by your country's deposit protection. Don't invest it. If prices fall just when you need the money, you'd have to sell at a bad time.

The second step is expensive debt. Credit cards often charge 18 percent a year or more. Leave a 1,000 dollar balance for a year at 20 percent, and it grows to about 1,220 dollars. Virtually no investment reliably earns that much.

So pay off the most expensive debt first, and pay the minimum on everything else. Treat other loans at about 8 percent or more the same way. Never invest with money borrowed on a card. And if you can't cover the minimum payments, get free debt advice first.

So remember: build a cash cushion first, starting with one month of take-home pay. Pay off expensive debt, highest rate first. And if there's little left over each month, these two steps are the whole plan for now, and that's fine. Before the next lesson, add up one month of your essential costs. In the next lesson, you'll see how money can grow on its own growth.