Overall, the cryptocurrency market is now worth over $3 trillion, which is an exciting milestone for the sector.
With all the hype, investors may feel tempted to buy in on the fear of missing out. But financial experts warn that cryptocurrencies are volatile, risky investments, and that you should only invest what you can afford to lose.
“In order to determine how much one can place into a riskier asset class, it is important to first assess your own financial health and make sure you are funding your required buckets first,” Anjali Jariwala, certified financial planner, certified public accountant and founder of Fit Advisors, tells CNBC Make It.
You should only consider investing in a riskier asset class, like cryptocurrency, once there are “no other buckets to fund and you still have excess cash flow,” she says.
Though the specific amount you can afford to put into cryptocurrency will differ from person to person, Jariwala recommends budgeting for a few key items first.
Your first priority should be paying off high interest debt, like credit cards and personal loans, Jariwala says. If left unpaid, the debt will compound and can become difficult and overwhelming to pay off.
The average credit card interest rate is currently more than 16%. And despite many Americans reducing their credit card balances during the pandemic, the average balance is still $5,525, data from Experian shows, with more than half of active accounts carrying over their balances each month.
While you are paying off your high interest debt, consider contributing to your 401(k) up to any employer match, Jariwala says. “The employer match is ‘free’ money, so it is important to take advantage of this,” she explains.
With a traditional 401(k), contributions are made with pre-tax dollars. This means that any money you put in comes straight from your paycheck, reducing your taxable income for the year. With a Roth IRA, you invest money that’s already been taxed. When you withdraw it in retirement, you get the gains tax-free, assuming you follow the withdrawal requirements.
After you have tackled your debt payments and are saving for retirement, “build up your emergency fund if you have not done so already,” Jariwala says.
She typically recommends saving three to six months worth of expenses, but this amount depends heavily on your personal situation.
To determine how much you should have in an emergency fund, start by adding up all your necessary monthly expenses, including rent, food, bills, loan repayments and insurance. Then multiply that total by the number of months you want your fund to cover.
Once you’ve funded all of these buckets, “review your personal finances and determine if there are any other buckets that need funding,” Jariwala says. This can include education funds for children, a down payment on a new home, home renovations and more.
“It is important to think about not only the upcoming year, but the next three to five years,” she says.
After allocating your income to the above expenses, along with your everyday living expenses, you can look at what’s left over and determine how much money you can afford to invest in a riskier asset class like cryptocurrency.