how much money to invest?

How to Determine How Much Money to Invest

Saving for the future is a laudable goal, but saving can only get you so far. You'll need to start investing if you want to start seeing your money really grow.

Investing can feel scary, especially if you've never done it. And there are lots of decisions to be made. But one of the very first decisions you'll need to make when beginning to invest is how much money you should be investing in the first place.

If that question keeps you from making the first step toward your financial future, here are some simple strategies for determining how much money to invest.

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What’s the difference between investing and saving?

You probably heard a lot about saving money when you were growing up. A rainy day is a proverbial target, whatever a rainy day might be.

Saving money—spending less than you make and setting some of the leftovers aside for future use—is an important part of every personal finance strategy. But it’s only part of the equation.

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Money saved as cash actually loses value over time due to inflation (a $100 bill can buy less today than it could a year ago). Savings accounts can help cover this loss, but most savings accounts pay far less interest than the average annual inflation rate of 2%. At the very best, saving money maintains its value and nothing more.

Investing, on the other hand, takes the money you’ve set aside and puts it to work for you. You can invest in just about anything you want. Traditional investments include things like stocks, bonds, mutual funds, Exchange-Traded Funds (ETFs), Certificates of Deposit (CDs), and Guaranteed Investment Certificates (GICs). You can invest in precious metals and even buy gold coins to take home. You can even invest in collectibles or a friend’s business.

Investing carries risk--the possibility that you could lose some or all of the money you invest. But money that’s invested also has a much better chance at growth than money merely saved. Smart investors choose a wide variety of investments chosen strategically to help them reach their goals.

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Should I invest my money?

Before you decide how much to invest, you need to ask yourself whether you should be investing at all.

Certain investments are much more personal than others. An investment in a home for yourself returns a lot more than financial growth. That’s not the kind of decision we’re looking at here.

Investing in the markets, however, is much more focused on growing your net worth.

Below are some questions you should ask yourself before you start investing your hard earned money.

1. Do I have debt, especially credit card debt?

The trick here is not to avoid investing if you have debt; it’s about making sure you’re not paying an undue opportunity cost.

If, for example, you have $10,000 in credit card debt and are paying an interest rate of 22%, it costs you $2,200 per year to carry that debt.

Chances are you’re not going to find an investment that rewards you more than paying off your credit card.

However, if you have a mortgage with a rate of 2.49%, chances are you could find several investments with a solid chance of earning more money than it costs you to not pay down your mortgage.

Before you invest, ask yourself whether it costs you more to borrow money than it can make by being invested.

2. What are my investing goals and time horizon?

Investing is typically most effective when done over the long-term. If you’re in your 50s or younger and saving for retirement, investing is likely a good strategy for you.

Conversely, if your goal is to save a down payment on a car you want to buy sometime next year, the ups and downs of the market and the cost of buying and selling investments mean you’re probably better off saving than investing.

How do I know how much to invest?

There are two ways to determine how much you should be investing: you can base it on how much you can afford to save and invest with your current budget, or you can base it on a set goal for the future.

1. The Budget Method

The simplest way to determine how much money to invest is to look at what works for your current budget.

You probably have a rough idea of how much money you make and what your major expenses are.

This is a good opportunity to write it all out and make sure you understand what your income and spending look like.

Assuming you make more than you spend, the next step is to determine how much of your savings you’ll need access to.

This could include an emergency fund (the recommended savings is at least three months’ pay), upcoming expenses (home repairs and vehicles are two of the biggest in this category), and a bit of a buffer for the unexpected.

You might also decide that you’re comfortable keeping only a portion of this in cash, but this will come down to your personal preferences.

If you’re a long way off from having the amount you need, you may want to keep most of your extra cash in savings and only invest a small amount.

Conversely, if you’ve got enough cash to cover all of these expenses, you may want to invest close to 100% of your future savings.

1. The Goals Method

Another way to decide how much money to invest is to work backward from your end goal.

Let’s say, for example, you want to retire at age 65, and be able to withdraw an average of $30,000 per year in retirement, adjusted for inflation, for 20 years.

Making some additional assumptions, like a 6% rate of return before retirement and a 2% rate of return in retirement. That means you need to have about $618,000 saved by the time you turn 65.

If you’re 40 years old, that means you need to invest just over $1,000 per month in order to reach your goal.

The AARP’s nest egg calculator does a great job of considering all the variables if you’re investing for retirement.

But Wait, What About Risk?

Generally speaking, you will want to choose investments best suited to helping you reach your financial goals.

If you’re relatively young and saving for retirement, you’ll want to choose riskier investments because you have a long time to make up for them if they don’t work out.

Conversely, if you’re planning to retire in the next few years, you’ll want to choose lower-risk investments that will still allow your money to grow but also be less vulnerable to big swings in the market.

Fortunately, these aren’t decisions you have to make yourself, and there are lots of resources out there to help you.

Fee-only financial planners can make really good recommendations and don’t earn any commission on the investments you buy. A financial advisor can help you set up a portfolio, but management fees can be expensive.

And newer services called robo-advisors automate a lot of the process and make it really easy to invest in the market without having to pick stocks or know the difference between a mortgage-backed bond and a real estate investment trust (because who has the time?)

Your risk profile may have some bearing on how much you choose to invest. If you choose less risky investments that have a lower rate of return, you might need to invest more money up front to achieve your long-term goals.

Our Final Thoughts

I’m a big believer that personal finance is just that: personal. And there is more than one right way to decide how much to invest.

If money is tight and you can only afford to save $50 a month, that’s still better than nothing, and that money can do a lot of good for you in the future.

You might choose to invest only a very small amount or take on low-risk investments, and that’s just fine.

Don’t worry about trying to live up to some ideal, like saving half of your income. Do what makes sense for you today, and if there’s a little leftover that you can use for tomorrow, then you’re doing something right.

If you’re working with a slightly bigger budget, it’s still ultimately up to you to decide how much you want to invest.

Frequently Asked Questions

This is a personal decision, but the answer is almost always yes! Every well-diversified portfolio should include at least some cash holdings and you will want to have money on hand to cover emergencies and major expenses.

Remember, it can be really difficult to access money invested in a registered account like a Registered Retirement Savings Plan (RRSP) or 401(k).

One strategy to simplify your mix of saving and investing is to use your savings account to fund your investment account.

This can keep your investments growing even if something comes up and you need to hold off on saving for a little bit.

Whether you are super rich and drive two luxury yachts at the same time, or you’re making minimum wage, you can invest!

The difference is likely in the types of investments you will want to make.

If budget is an issue, start small and prioritize paying off high-interest debts and building up a solid emergency fund over investing.

Generally speaking, young people should take higher risks when investing if the goal is retirement.

Higher risk means higher returns, assuming all goes right. If things don’t go right, young people have a lot more time to make up any losses.

But retirement isn’t always the goal. For example, you might be saving for your child’s education. And while you might still consider yourself pretty young, you will want to take fewer risks with that money as your child enters high school.

Whatever you’re investing for, you will generally want to reduce the amount of risk in your investments to protect what’s already accumulated as you get closer to your goal.

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