How Much of Your Income Should You Invest?

Nearly half (45%) of all Americans regret not having invested in the stock market earlier. The truth is that stocks can be a great way to build wealth. But if you’re new to the world of investing, you might be asking: “How much of my income should I invest?” 

The answer depends on your financial goals, but the following principles will help you form a strategy that works for your budget. If you need additional assistance, look into an investing platform to help you perform additional research and maximize your returns.

First Plan Your Investing Journey

Before you think about “what” to invest in, think about “why” you’re investing. Develop a plan that accounts for the following considerations.

Goal

Start by defining your goal. Sure, your goal is to make money, but for what purpose? Common investing goals include retirement, saving for a house, buying a dream home, funding your children’s education or leaving an inheritance.

Timeline

Once you define your investing goals, you can then establish a timeline. This timeline should include a target date for using your investment — such as the year of your retirement — and benchmarks along the way to help you track your progress.

Your age will naturally impact your timeline. Younger investors can generally take on greater risk and adopt a more aggressive investing approach since they have more time to adjust their portfolios. Older investors might pursue diversification and other ways to protect their investments as they near retirement — or focus on other retirement vehicles, such as making catch-up contributions to their employer-funded retirement accounts. 

Risk Appetite

Investing always involves some degree of risk — though your potential reward is often proportional to the risks you take. To use the earlier example, Amazon would once have been considered a risky investment, but its meteoric rise shows that startups can offer substantial growth potential.

That said, not every stock will achieve this level of explosive growth. Investors must decide how comfortable they are with risk before investing in similar companies. Again, age becomes a factor. Younger investors will have more time to make adjustments to their portfolios, which means they can choose to take on more risk.

3 Ways of Allocating Money for Investments

Once you define your goals, your question may still remain, “How much of my income should I invest?” There’s no right answer to this question, but the following guiding principles can help you decide how to devote your resources to your investing account.

1. 50/30/20 Budget Rule

This is a simple budgeting principle in which you'll devote 50% of your income to your needs, 30% to your wants and save or invest the remaining 20%.

For example, imagine you earn $5,000 each month after taxes. You can devote $2,500 to needs such as your mortgage, utilities and other living expenses. Then, you can use $1,500 on wants, such as entertainment or dining out. The remaining $1000 can be devoted to your savings and investment account.

This may mean dividing this 20% between your short-term savings and long-term investments. But once you build an emergency savings fund, you can allocate more of the 20% to your investment account.

2. 15% of Your Pre-Tax Income

Another guiding principle is to invest 15% of your pre-tax income. This includes any employer match.

This number may vary based on age, though it’s probably better not to go significantly below this figure. As you grow older — and you’re close to paying off your mortgage — you can increase the percentage you put toward your retirement plan.

3. Invest Only What You Can Afford to Lose

It may be tempting to sink your savings into that hot new startup, but be cautious. Never invest more money than you can afford to lose.

If you’re married, this means talking over your investment decisions with your spouse and considering your mutual plans before making any major decisions. That way, you’ll be on the same page, financially speaking, and can plan for the future together.

Factors to Consider Before Investing 

Now that you have your goals in place and a general idea of your strategy, take stock of the current state of your finances. Before you invest, consider the following.

1. Income

What is your income? Make sure you have enough to budget toward saving and investing. You may need to adjust the above suggestions to fit your situation. For example, if your living expenses take 60% of your income, you may choose to devote 25% of your income to hobbies and only 15% to saving and investing.

2. Debt Balances

If you’re in debt, paying this off before investing is important. Why? Since 1926, the stocks of large companies have yielded an average return on investment of around 10%. That’s typically lower than the interest rate on credit cards or other consumer debts. 

In other words, it makes more financial sense to eliminate your high-interest debts before investing.

3. Emergency Savings

It helps to have an emergency fund set aside for unplanned expenses. Aim to set aside three to six months' expenses before you make major investments. This will help prevent you from dipping into your primary savings account if you need to pay for an unexpected car repair or medical bill.

Plan for the Future with Confidence

Through careful planning and strategy, you might never see the kind of success of Amazon stock, but you can at least plan for the future with confidence.

Your investing and saving rates will depend on your financial goals, but most investors should consider starting at around 15%. You might never see the kind of success of Amazon stock, but you can at least plan for the future with confidence.

Frequently Asked Questions