The start of a new year is often when people set goals for the next 12 months and begin making plans to achieve them. Naturally, this means it’s the perfect time to assess your financial situation and determine how much you might invest in the coming year.
By researching your current budget, you’ll be able to determine how much of your money you can comfortably contribute toward your investment goals. This process also provides useful information for your financial advisor to help guide your decisions.
Whether you’re creating your first investment budget or updating a current one, there are four basic steps you should follow. These ensure that you’ll be able to maximize your investments while still being able to comfortably meet your other financial obligations.
1. Assess your current financial situation
Take a look at your current budget to get a sense of how much money you’re taking in each month, how much you’re spending, and how much you’ll be able to set aside. This process will also update you on the progress you’re making toward any short-term or long-term goals.
Check the past two or three months of your financial activity and plot out the following:
- All sources of monthly income
- Regular monthly expenses including mortgage or rent payments, minimum debt payments, utilities, and groceries
- Discretionary monthly expenses such as gym memberships and dining out
- The remaining principal and interest rate on your debts
- The balance of all of your savings and investment accounts
- Existing contributions toward your retirement fund and other investments
Creating this budget will show how much of your income you could potentially contribute to an investment portfolio. It will also let you determine if there are any areas where you might be able to adjust your spending. For example, you may opt to reduce the amount you spend each month on dining out or cancel some subscriptions in order to have more discretionary income available to invest.
2. Determine how much you can invest
One common recommendation for dividing up your after-tax income is a 50/30/20 distribution, which aims to strike a balance between meeting your basic needs, spending on discretionary items, and addressing long-term goals. This distribution commits:
- 50 percent of your income to essential needs
- 30 percent for discretionary spending
- 20 percent for savings and debt repayment
Investments complicate this model to some degree, as you can consider them as a form of both savings and discretionary spending. Depending on your personal financial situation, you may opt to invest a larger share of your income (such as 25 percent) or a smaller share (10-15 percent).
Even if a larger share of your income goes toward covering basic needs and you only have a small share of your budget available for investing, you can still take this step. One common misconception is that you need to have a substantial amount of money available in order to invest. In reality, you can start an investment portfolio with a modest sum that fits your budget. You can even opt to commit a set dollar amount for investing each month rather than a specific share of your income.
Time is the most important consideration when investing. The earlier you start an investment portfolio, the longer it will have to grow. Committing to regular contributions toward your portfolio, even if it’s just a small amount of money, will allow you to grow your assets more quickly over time.
Look into setting up automations to help support your investment goals. These could include an automatic transfer to shift some of your income to your investment portfolio each time you receive a paycheck.
3. Set your goals for investing
Once you know how much you can comfortably set aside, you should set goals you’d like to accomplish through your investments. Some common goals include having enough money to:
- Retire
- Pay for your children’s college education
- Make a down payment on a house
- Purchase a vehicle
- Enjoy a nice vacation
Your goals will dictate your investment strategies, since they will help you decide how much risk you’re willing to take on and how long you’ll need to save. For example, saving for retirement takes place over a long period of time and usually includes an adjustment of risk strategy (from higher-risk investments at a young age to more conservative investments as you near retirement). Saving for a children’s college fund is also a long-term process, typically accomplished with a tax-advantaged 529 plan. By contrast, investments intended for wealth accumulation often have a shorter timeframe and may pursue more of a high risk, high reward strategy.
You may decide that short-term financial obligations should take precedence over investing. These could include paying off high-interest debts or building up an emergency fund sufficient to cover at least three months of living expenses. Once you have achieved these goals, you’ll be in a better financial situation and can invest more comfortably.
4. Make adjustments as necessary
An investment plan is not something you set and forget. You’ll need to revisit it periodically and make adjustments to reflect changes to your budget as well as your investment goals.
You may be able to invest more of your income if you receive a raise, pay off a debt, or no longer need to pay for an expense such as child care. However, you may also want to reduce the amount you invest if you have taken a pay cut or are coping with higher expenses.
You should ideally review your investment plan at least once a month with your financial advisor. This will allow you to make adjustments quickly based on any changes to your circumstances.
To set up a meeting with Grey Ledge Advisors, contact us online or call 203-453-9075.