It would be a mistake to think that the money you are making today is the money you should be spending today. Doesn’t it make sense to think you should set aside savings and invest some of those savings for future use? Assuming you agree with this position, you need to ask yourself how much of your personal savings should you invest.
The Difference Between Saving and Investing
At a very basic level, saving money refers to taking income and setting some of it aside for a rainy day. People who are merely saving money don’t really care about the earnings they could be making by investing their savings. They tend to view saving money as a means of safety or security..
While saving money doesn’t involve much risk, investing money does.. A good investor or investment professional would be quick to state that there is a direct correlation between risk and reward. The more risk an investor is willing to take on, there is usually higher the potential large return.
Examples of Risk/Reward Investing:
A conservative investor might invest in utility stocks that offer dividends and predictable appreciation into the future. Or, they might leave money in a savings account to accrue interest.
Conversely, a risk-taker might invest in something like BYU NFT football cards, hoping for great appreciation coming in the future. The appreciation is largely unpredictable because it relies on so many unpredictable variables such as decisions made by direct stakeholders, the team’s performance, and other events affecting the team or school’s reputation. The return might come, or it might not.
How Much of Your Personal Savings Should You Be Investing?
Let’s assume you have decided to go with conventional wisdom and start investing at least some of your savings. Since you have been reluctant to do so in the past, you are wondering how much of your savings should be invested. Try the following approach.
Determining Available Discretionary Money
Anything that you might save and or invest would have to come from your discretionary money. Discretionary money can best be defined as the difference between your total net income and what you need to cover your bills.
Setting Savings Goals
After establishing how much discretionary money you will have each month, you should be able to target a basic savings amount. It might help to view basic savings as liquid money, the money you can get your hands on with relative ease.
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Why would you need to quickly get your hands on money? There are things that could happen to you or your family in the near future. With that in mind, here are some reasons you might prefer to keep money in savings:
- To cover medical emergencies
- To accumulate money for a major purchase in the near future (vacation, furniture, car, house deposit)
- To satisfy your preference for low risk-tolerance
Setting Investment Goals
Once you know how much you want or need to put in basic savings, you’ll then have an understanding of how much you should have available for investing.
Before you start building an investment portfolio, there are several investment questions you will need to address. That would include:
- Your future cash needs, including retirement
- Your risk tolerance level
- Investment allocation methodology (what investment tranches will you use)
- Expected “Return on Investment” (ROI)
Using the answers to these questions, you can start building your investment portfolio. All that’s left to do is to determine how much of your savings you will be investing each month.
Determining Your Investment Amount
If you ask 10 investment professionals how much you need to invest each month to meet your stated goals, you would likely get 10 different answers. With that said, it’s best to keep your savings/investment decisions as simple as possible.
You could try to go through some very complicated calculations to get an answer. Or, you might be better off following one very basic rule: Invest the entire amount of savings that you don’t need to set aside as basic savings.
The bottom line is this. You should always have an eye on the future when you are making savings or investing decisions. While your income will likely increase in the future, there is always a chance adversity will strike making it necessary to use your savings a lot sooner than you planned.