Personal Finance 101: How to Think About Investing as an Individual
The "Personal Finance 101" mini-series will provide guidance on wealth management topics for individuals. Where possible, we will be tying these topics back to sustainability themes.
Source: Wilson Porter
Personal Finance 101: How to Think About Investing as an Individual
Break Down Your Budget
For any young person looking to start budgeting, saving for retirement, and setting aside money to invest, the best place to start is understanding your spending habits. There are a lot of ways to do this – most credit card companies and commercial banks provide dashboards that break down spending into various categories. If you, like us, have a variety of different bank accounts, credit cards, online payment platforms (like Venmo and Paypal), and brokerage accounts, Truebill is a great way to aggregate all of this information in one place (and no, they aren’t paying us!).
The most popular method for budgeting is the 50/30/20 rule, which recommends dividing your income into 50% for needs, 30% for wants and 20% for savings, investing, and paying off debt[1].
Needs: 50%
Within the 50% allocated to “needs”, a general rule of thumb is to spend 30% of your income on rent[2]. This leaves 20% for other needs like utility payments (gas, electricity, water, wifi, cable), insurance (health insurance, car insurance, renters insurance, personal property insurance, pet insurance), groceries & pet food, and minimum debt payments.
Wants: 30%
“Wants” is perhaps the most fun category. This is going to be entertainment expenses (like dining out), shopping, other pet-related expenses, concerts, travel, etc. The “wants” category is perhaps the most variable component of a personal budget, but individuals should aim to spend 30% on average throughout the year.
Saving/Investing: 20%
One helpful method for ensuring that you are saving and/or investing that full 20% is directing it straight from your paycheck to a savings or investment account[3]. Some experts suggest further breaking down that 20% into 15/5, with 15% dedicated to investing for retirement and 5% for short-term savings (such as an emergency fund or savings buffer)[4].
Starting with the 5% dedicated to savings – generally, the first goal is to establish an emergency fund or savings buffer. The goal for this money is to cover any financial surprises that life sends your way (including job loss, medical or dental emergencies, home repairs, car troubles, or unplanned travel). For a young person, the goal is to build up funds to cover 3-6 months of expenses. The amount of money needed for a savings buffer will increase over time, as living expenses increase. T. Rowe Price recommends the following benchmarks[5]:
· By age 30: Savings amounting to half of salary
· By age 40: Savings amounting to 1.5 to 2.5x salary
· By age 50: Savings amounting to 3 to 5.5x salary
· By age 60: Savings amounting to 6 to 11x salary
Next, we have the 15% of income to be invested. Part of that 15% should include contributing enough to your 401K to meet the employer match (typically 6%). Now, we have broken down the 20% into 6% for a 401K and 5% for a savings/emergency fund, which leaves 9% for investing.
Knowing Your Objectives
When thinking about self-managing your own assets or hiring a wealth manager, it’s important to understand your “return objectives” (i.e. are you looking to grow your money a certain percentage or are you looking to have a similar performance to the broader market?), “retirement goals” (i.e. when do you plan to retire? how much money will you need to sustain your lifestyle upon retirement?), “funding priorities and other financial foals” (i.e. are there other goals in addition to retirement? Are you planning to buy a house? Are you saving for a child’s education?), “investment preferences” (i.e. are there specific things you prefer to invest or not invest in? For instance – an investment preference could be investing in companies with more sustainable business practices), and finally “risk profile” (including “risk tolerance”, which is the willingness to take on risk; “risk capacity”, which is the ability to take on risk; and “risk perception”, which is how you think about and assess risk). Additionally, it is important to plan for unexpected events such as medical expenses for yourself or your family, uninsured property repairs, and other unforeseen expenses.
Allocating Investments
When you are young, you have a longer time horizon until you will need your money, which may allow you to pursue higher returns and accept a higher degree of risk. Typically, the biggest investment milestones are going to be the purchase of a home, funding a child’s education, and retirement. Each of these milestones comes with its own time horizon, and investments should be structured accordingly. Experts suggest investments with the highest return potential and risk (such as equity investments, alternatives, etc.) to fund needs with the longest time horizon. For a milestone with a shorter time horizon, experts suggest reducing the risk in your portfolio by including more defensive equity investments and potentially adding more fixed-income investments[6].
Additionally, it is important to consider market dynamics. Amid higher inflation, as is the case in the U.S. right now, you should strive to set aside even more of your paychecks for investing and saving, according to Craig James Ferrantino, a certified financial fiduciary and founder of Craig James Financial[7].
[1] https://www.marketwatch.com/picks/how-much-money-should-you-really-be-investing-during-periods-of-higher-inflation-01635875513#:~:text=Experts%20generally%20recommend%20setting%20aside,which%20we%20will%20discuss%20below
[2] https://www.nerdwallet.com/article/finance/money/how-much-should-i-spend-on-rent#:~:text=How%20much%20should%20you%20spend,%24840%20per%20month%20on%20rent.
[3] https://www.marketwatch.com/picks/how-much-money-should-you-really-be-investing-during-periods-of-higher-inflation-01635875513#:~:text=Experts%20generally%20recommend%20setting%20aside,which%20we%20will%20discuss%20below
[4] https://www.fidelity.com/viewpoints/personal-finance/spending-and-saving
[5] https://www.troweprice.com/personal-investing/resources/insights/youre-age-35-50-or-60-how-much-should-you-have-by-now.html#:~:text=So%2C%20to%20answer%20the%20question,saved%20about%20%2460%2C000%20to%20%2490%2C000.
[6] https://www.investopedia.com/articles/personal-finance/022216/i-make-50k-year-how-much-should-i-invest.asp
[7] https://www.marketwatch.com/picks/how-much-money-should-you-really-be-investing-during-periods-of-higher-inflation-01635875513#:~:text=Experts%20generally%20recommend%20setting%20aside,which%20we%20will%20discuss%20below
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The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice.
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