When thinking about how much money to invest, it can be tempting to look at how much money you have, but you should also think about how much money you need. While this isn’t always a “fun” question to think about, ask yourself, “What are my goals and what am I trying to accomplish?” Advises Audrey Blanke, Certified Financial Planner at Baird. With that information in mind, you can then turn to “proven rules of thumb” that will help you get started, she adds. Experts generally recommend setting aside at least 10-20% of your after-tax income to invest in stocks, bonds and other assets (but note that there are different “rules” in times of inflation, including we will talk about below). But your current financial situation and your goals may dictate a different plan. Here’s what you need to know.
Use the 50/30/20 budget rule as a starting point …
A popular method of budgeting – the 50/30/20 rule – recommends dividing your after-tax income as follows: 50% for needs, 30% for wants, and 20% for savings and debt repayment. This 20% threshold covers both short-term savings, such as an emergency fund, and longer-term goals, such as buying a home or investing for retirement.
The 50/30/20 rule is a good way to build savings into your monthly budget or spending plan, says Matt Schwartz, a certified financial planner at Great Waters Financial. This type of budget also forces you to think about your priorities, he adds. “You have to weigh what my lifestyle is like and how am I going to enjoy the fruits of my labor, not only in the future but today.”
Once you’ve decided on a plan for your 20% savings goal, it’s important to automatically transfer that money to an investment account with every paycheque, just like you do with contributions to a 401 (k ), advises Schwartz. Having a plan in place will also help you avoid the temptation to spend money intended to invest in something else. “We know that once this money gets into our checking account, it’s like we never got it.”
… But your financial situation may require adjustments to this rule
A rule of thumb, like the 50/30/20 budget, is a good framework to start thinking about how much of your income should be spent on investing. But for many people, such as those in their 20s, that amount may not be realistic, notes Blanke.
Instead, you may need to gradually hit a 20% savings goal early in your career, notes Blanke. And it’s okay not to maximize the amount you can invest to focus on other short-term priorities like paying off debt, buying a house, starting a family, or giving yourself the chance to take a break from the world. work, she adds. “For people with larger student loan balances, it’s really hard to hit that 20% threshold.
Reassess your investment contributions and consider increasing the amount you invest
Just as your financial situation will change as your career progresses or your personal life changes, so should your investment goals change. In a context of higher inflation, as it is in the US economy right now, you should strive to set aside even more of your paychecks – think: 25% – to invest and save, according to Craig James Ferrantino, certified financial planner and founder of Craig James Financial.
“If we save too much money, we can always use it if we need it,” says Ferrantino. “But if I save too little and inflation persists, then I’m going to have too little money when I need it.”
Finally, it’s important to remember that your investment goals can and will change. While Schwartz recommends an annual review of your plan, Blanke says you should also see if you have any extra money at the end of the year that you can spend on investing. And even if the amount you invest fluctuates, it helps to establish investment discipline early on and then stick to it no matter what is going on in the market at that time.
“Remember the saying: time in the market is more important than timing in the market,” says Blanke.