Before building a portfolio of stocks and shares, it is important to lay the financial foundations. Follow the five tips described here to ensure you enter the stockmarkets on a solid foot, debt-free and with money in the bank.

There are very good reasons to invest in stocks and shares, and other financial instruments, but as with many things in life, timing is everything. Luckily, there are some well established rules to help us towards financial success. Follow these simple steps and you will feel more confident when the time comes to enter the world of stockmarket trading.

1. Ditch the Debt

If you have any debts, get rid of them as a matter of urgency. Remember to consider the interest rate – this is very important. It is a false economy to try and build up savings while you are in debt. This is because you typically pay far more interest on borrowings than you will receive on your savings. So if you have spare cash in your pocket and are currently in debt, use this extra cash to pay it off first – debt in this case means credit cards, store cards, loans and overdrafts. Pay these off first – then start saving some money.

2. Save Cash for Emergencies

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Once you are debt-free, your first savings objective will be to build up an ‘emergency fund’. Aim to reach at least six months of current salary as a buffer to pay for unexpected emergencies, or pay the bills if the worst happens and you lose your job. This cash should be held in an instant access account, and pay the highest interest rate you can find. At this point don’t worry about getting the very best rates, as these accounts may require you to give notice before withdrawing cash – not what you want when you’ve got urgent bills to pay.

3. Become a Regular Saver

Now you are debt-free and have a cash buffer to tide you over in times of disaster, it is time to start saving regularly. The aim is to find the best returns available – and don’t hesitate to switch to better accounts as and when they appear. Lots of savings accounts have introductory bonuses added to their interest rates. Feel free to take advantage of these, but always remember to investigate other options when the introductory period finishes.

In the world of bank and building society accounts: loyalty is for losers!

Don’t forget to check what deals are available for cash ISAs (UK only) because they let you earn interest tax-free on an annual amount of upto £3600 (2009). But do a few calculations first – if you find an account that offers net interest which is still higher than an ISA rate, just pay the tax and enjoy the return on your savings.

Remember finally that savings in UK banks and building societies are protected upto £50K by the Financial Compensation Scheme.

4. Pensions and Mortgages

The next thing to consider before diving headlong into the stockmarket is where else your hard-earned money can sensibly be employed. If you have a mortgage and your provider allows it, perhaps you could think about overpaying. Thanks to the wonders of compounding – you’ll see this on your savings over time – you can vastly reduce the overall amount of interest you pay on your mortgage by making overpayments now. And you can shorten the time required to pay it off as well!

If you have a pension or several of them, you might wish to increase your payments into these schemes – remember (in the UK) they are tax-efficient savings vehicles. However, if you joined a scheme very recently it is unlikely to be a ‘final salary’ scheme. The more recent pensions simply allow you to save money and invest it in all sorts of ways until you retire. You then buy an annuity with it to provide retirement income – which will be taxable.

So these are a couple of options available which should involve less risk than investing directly in company shares.

5. Get Advice!

Assuming you have already dealt with steps 1 to 4 above, the next stage – possibly the most important stage – is to seek professional advice. Find a reputable, fully-qualified and registered Independent Financial Advisor (IFA) – in the UK they will be registered with the Financial Services Authority (FSA).

Some IFAs charge a fee for their advice, others provide you with products and take a commission, others a combination of the two. If you go via the commission route, make sure the IFA can offer products from the whole market and is not attached to a particular provider (this should not happen with a truly independent IFA).

It is also worth getting independent advice on pensions and mortgages at this point to ensure your capital is being allocated wisely. Everybody’s financial situation is different and so it is worth repeating that good advice here is worth its weight in gold.

Of course, you are not forced to seek advice before you start investing in the stockmarket. It is perfectly possible to do your own research and succeed. All stockbrokers will ask you to sign a declaration that you understand the risks involved in stocks and shares dealing. And if you do decide to take the plunge, always remember that sometimes the best trade is not to trade – most people lose money by letting their emotions take over their decision-making and they end up overtrading!

Useful Links

The London Stock Exchange

Money Saving Expert – Martin Lewis

Fool.co.uk – Seriously Good With Money (UK)

The Motley Fool – the US version, more stocks biased

UK Investing – various investment options in the UK