We’ve covered a lot of financial topics, and I’ve done my best to go over the common questions that I get asked. Today I’m going over another one of the most common questions people send my way, and it’s one that is hard to answer. How much you should invest is a very personal matter, so it varies. In this article I’ll be doing my best to break down how much you should invest as a general rule of thumb. On top of that, I’ll go over some of the ups and downs of investing more or less than what I suggest.
It Depends On Your Goals
As I just said, how much you invest is a personal matter. It will depend entirely on your personal goals and where you want to end up in the long run. So, before you dive further into this article, there are some additional resources you may want to use.
If you have absolutely no idea where you want to be, check out my article on setting and reaching financial goals. It covers short-term, medium-term, and long-term goals plus the article includes a free financial goals worksheet for you to get started with.
If you haven’t done the legwork for planning your retirement, get started with my article on it. If you already understand your financial goals and basic retirement plan, then how much you invest will fall into place more easily.
Whatever You Decide, Be Sure To Automate It
I feel like this is such a common statement in the personal finance community that it almost doesn’t need to be said anymore. However, not everyone is even aware that you can automate this stuff, much less understand how much easier that makes life.
So, for those of who you don’t know, I want to share some tidbits about automation. Most brokerages these days try to make it as easy as possible to set up automatic investments. Make use of it. Yes, it makes managing your finances much easier and less time consuming. Also, as an added bonus, automating it ensures that you stay completely consistent.
If you’re a beginner, try using an app like Acorns to learn the ropes. You can link your cards to it and then it will round up every transaction to the nearest dollar. With the spare change it then starts saving and investing the money on your behalf. It adds up quickly and is a great learning tool. If you already know the basics, then I recommend trying a brokerage like M1 Finance, as I love their system.
Do A Percentage, Not A Flat Amount
This is just my personal opinion, but when setting investment goals I think it is best to invest a percentage of your income. Obviously that will be a fairly consistent amount, but the purpose is to make sure the amount you invest increases with your income. So, every year or so I recommend looking at your current income and adjusting how much you invest based on that. This way you can avoid lifestyle creep, to a certain extent.
Pre-Tax Vs Post-Tax
Now, whether you invest a percentage based on your post-tax or pre-tax income is up for debate. Personally, I like to use my post-tax income to set my investment goals. Unfortunately using your pre-tax income can make it a bit more complicated, but if you want to use pre-tax income that is perfectly fine. The only caveat with using your post-tax income is to remember that your 401k contributions are based on pre-tax income.
Of course, all of that sounds complicated, and if it is confusing you then don’t worry about it. Just calculate how much money you’re netting each month after taxes, then invest based on that amount.
10% Of Your Income
Investing 10% of your income should be an absolute bare minimum. Investing this much will get you on the right track, and if you make an average income or more then this shouldn’t be a difficult goal. You’ll have a decent chunk of money due to compound interest eventually, but it may not be enough. Depending on how long you plan on working, and how much money you need in retirement, you could (and probably will) fall far short of what you need.
Consider 10% a baseline. It’s a good place to start, and be proud of yourself for taking the effort to save this much. However, if this is where you’re at be sure to increase how much you invest to match where you want to be in the long run.
15% Of Your Income
Investing 15% of your income puts you at a much nicer spot. I still wouldn’t say it’s ideal, but it’s much more realistic to meet your retirement goals with this amount. If you are several decades from retirement, and you plan on living off a smaller amount once you retire, then this could be enough. With that being said, for most people 15% won’t quite cut it. However, 15% puts you in a good spot, and even if it isn’t where you need to be, it shouldn’t be too hard to catch up a bit.
It’s also worth noting, if you’re investing 15% of your pre-tax income, you should start feeling a LOT more secure.
20% Of Your Income
20% is the ideal spot in my opinion. I still recommend investing more if you can, but once you’re saving 20% of your post-tax income, you’re usually in a decent position. If you started investing somewhat early in your career, and you plan on retiring at a normal age, then 20% can be enough to meet your goals in a lot of situations.
If you aren’t investing 20% of your income already, make that a priority. Follow good budgeting tactics, increase your salary, and do what you need to get there. Once you’re at 20%, invest more as you’re able, but don’t forget to avoid lifestyle creep. As your income increases, simply invest more. Do NOT increase your expenses simply because your income is increasing. Your expenses generally shouldn’t increase except after major life events like marriage or having a kid.
50% Of Your Income
To be fair, I’m well aware that investing 50% of your income isn’t feasible for most households. With that being said, once you start investing more than 20% of your income, you’ll start seeing absolutely astounding returns. If you’re able to invest 50% of your income, then you’re actually well on your way to retiring early! This puts you far ahead of schedule and gives you a lot more flexibility with what you want to do with your future. Again, I know this isn’t feasible for everyone, but it’s a worthwhile goal to try to achieve, especially if you want to retire early.
Retirement Accounts
I’ve gone over many different retirement accounts in past articles, so I won’t go over all of them here. Instead, I’ll go over the two retirement accounts that will apply to the overwhelming majority of people.
Traditional 401(k) Matching
In a traditional 401k, your contributions are deducted from your taxable income. This means that your contributions are made tax-free, but you will have to pay tax on them when you withdraw them in retirement. This can be a good thing since a lot of people will be in a lower bracket when they retire. However, it is always unknown how policies and taxes will change in the future, so you can never be completely sure how it will end up being in the long run.
With the traditional 401k there is one key takeaway that everyone should know. Many employers will match your contributions to your 401k, up to a certain point. For example, if a company matches your contributions up to 5% of your income, that means that when you contribute 5% of your salary, the company matches that dollar for dollar. So, buy investing 5% of your salary, in that example you end up investing 10% of it instead! Many people argue over the merits between different retirement accounts, but is is a generally good idea to at least contribute whatever your employer is willing to match.
Ensure you know how long you have to stay at a company for the money they match to vest. Sometimes you get to keep that money starting day 1, other times you have to wait a year or more before all of their contributions are officially yours. This tactic is usually something companies do to try to entice employees to stay on for longer periods of time.
Roth IRA
Roth IRAs use contributions that have already been taxed. While that seems unfortunate now, it does mean you won’t have to pay taxes on them later on, which could turn out in your favor (but it could also work against you too). The main issue for Roth IRAs is that they have an income cap, so once you make over a certain amount you can’t contribute to it anymore. Additionally, for everyone, there is a hard cap on how much you can contribute to your Roth IRA every year. With that being said, meeting your 401k match and then trying to max out your Roth IRA contributions is a great goal!
Early Retirement
As and added tibdit, I wanted to mention something for those whose goal is to retire early. Depending on how early you plan on retiring, you may want to make additional contributions to standard accounts, so that you can withdraw money from them as early as you need. For that, I recommend M1 Finance or Vanguard (both of which also have IRAs you can use).
The Longer Your Timeline, The Better
Your investments will ramp up over time. The longer you plan on investing, without withdrawing, the less you have to invest to reach the same goal. However, investing more can shorten how long you have to invest. So, make sure you’re on track to reach whatever goal you’ve set.
Conclusion
Hopefully this answered your questions regarding how much you can invest. Shoot for 20% as a general rule of thumb, and if you can push for even more that is great! Investing 50% will put you on the fast track for an early retirement. For context, at the time I’m writing this article I invest about 45% of my post-tax income. It’s not as much as I’d like, but I’m proud of how much I’m able to put away – and I know it’s a lot more than many can afford to, especially if kids are involved. For more content like this, and a free budgeting template and financial goals worksheet, be sure to sign up for the Bitter to Richer newsletter.
