Determining how much money to invest is a highly personal decision that depends on your unique financial situation, goals, and risk tolerance. There’s no single magic number, but several principles and rules of thumb can help you create a personalized plan.
The Pre-Investment Checklist
Before you start investing, most financial experts recommend you have these things in order:
- Spend less than you earn: This is a no-brainer. Spending less than you earn is the single most important principle of personal finance and the foundation for building wealth.
- Pay down high-interest debt: Focus on paying off debts like credit card balances or personal loans first. The interest you save by paying off this debt is often a guaranteed return that is higher than what you might earn through investments.
- Build an emergency fund: Have a savings account with enough money to cover 3 to 6 months of essential living expenses. This fund is your safety net for unexpected events like job loss or medical emergencies, preventing you from having to sell off your investments at a bad time.
- Create a budget: Understand your monthly income and expenses to determine how much money is left over that you can realistically set aside for investing.
The Rule of Thumb: 50/30/20 Rule
A popular guideline for budgeting and investing is the 50/30/20 rule:
- 50% of your after-tax income goes to “needs” (rent/mortgage, groceries, utilities, transportation).
- 30% of your after-tax income goes to “wants” (dining out, entertainment, hobbies, travel).
- 20% of your after-tax income is dedicated to savings and debt repayment. This 20% is where your investments would fall.
Many experts suggest aiming to invest 10% to 20% of your income for retirement, especially if you start early. This percentage can include any employer match to a 401(k) or similar plan.
The most important thing is to start. You don’t need a huge lump sum to begin. Thanks to modern technology, many platforms like Robinhood, allow you to start with very little money. The earlier you start investing, the more time your money has to grow and generate its own returns. Even a small, consistent investment over a long period can lead to significant wealth accumulation
My personal Take
I have kept aside 6 months worth of monthly expenses as emergency funds in my savings account. That’s the amount I am comfortable with. Apart from that, I invest every single dollar I have left after paying for all expenses. A key reason behind that is inflation.
Inflation is the rate at which the prices of goods and services increase over time, leading to a decrease in the purchasing power of money. When inflation occurs, a unit of currency buys fewer goods and services than it did before. Look at the inflation is USA in past 10 years.
Every year, our hard earned dollars are loosing value. If we had just kept our money in savings account in 2022 without investing, the value of our money had gone down by 8% in that single year. The value will keep going down year over year if we do not invest the money to generate a return to counteract the drop in value.
In conclusion, the amount you should invest is a personal decision that requires a careful assessment of your financial situation. By following sound budgeting principles, addressing financial prerequisites, and starting with a manageable amount, you can begin your journey toward achieving your long-term financial goals.
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