How much money do we need before we can start investing? One of the most imperative questions posted by people looking to start investing. Very often, the emphasis is placed on the wrong issue as amateur investors worry about what is the correct minimum amount to start with. Instead of being concerned over whether you have that amount required to start investing, the core focus should be on whether you have allocated your money in a sensible way with a portion set aside for investing purposes while fulfilling the other financial obligations at the same time. You can see this as working backwards to determine how much you can possibly invest based on the finances you have.
The concept of minimum capital is non-existent
The starting capital for investment can range from a modest amount of a few hundred dollars to a hefty sum, depending on your current finances. A young investor may only have a few thousand dollars to spare for investments while a full-time employed investor can possibly fork out more. The critical element is one of time. That is, the essence lies within how early we start to invest. The earlier we start, the more prominent the compounding effect will be. This means that if today, you start investing early with a small capital sum, there is a better prospect of growing your money as compared to leaving it in the bank account. You may want to read up on our “Debunking The 3 Biggest Excuses For Not Investing” article, where we discuss in detail the common misconception that ‘I am not rich enough to start investing’.
Knowing how to save before learning how to invest
Although time is key, one also has to look at whether his current financial state is healthy enough to start investing. This is created through a disciplined habit of saving and managing spendings. It would be better that you have at least S$6,000 of savings before beginning to invest. Else, a better approach would be to first learn to start saving more before moving into investments. There can possibly be two reasons if you do not at least have S$6,000 of savings now — either you have just started working and saving up, or that you have not been saving much of your money over the years. In both situations, you need to first learn how to stay disciplined to save up before moving on to investments. This will then create a healthy financial position before you can invest with a peace of mind.
The path to investment can be summed up using the SPEED acronym:
The first step to investment is to ensure that you have a steady source of income. This steady source of income can be derived from your employment with a company or as a self-employed entrepreneur. A steady source of income ensures that you have the finances required to pay for your expenses, savings, and investments.
Next, ensure that after settling all your present financial obligations such as credit card bills and transport expenses, there is leftover money available to be saved, invested or both.
Another important step is to plan for the potential expenses required for the upcoming events or changes in life such as marriage or getting a BTO flat. This category may potentially reduce your savings or finances considerably and thus reduce the amount available for investment purposes.
Set aside sufficient funds as emergency funds. This will be covered in more detail in the next section.
Lastly, devise an investment plan. This investment plan should include learning the basics of investing, performing thorough research on the securities you are looking to invest in and setting the appropriate expectations for your investments.
While it is true that you can start investing with as little as a few hundred dollars, the focus should be on whether you already have a disciplined amount of savings and spending habits before setting aside some money to start investing. If we have been maintaining disciplined spending and savings habits, how much of our salary should we set aside to do investing?
The core focus should be on the proportion of your salary to allocate to investing
The main reason people invest is to make their money grow. This can be for early retirement goals or for a more extravagant and indulgent lifestyle. But before we invest for those goals, we have to ensure that investing does not hinder or disrupt our current life. An intelligent investor has a plan in mind — he ensures that he works on an allocation plan to properly allocate the percentage of his monthly salary that goes into expenses, savings and investments. An intelligent investor ensures that he can invest with greater peace of mind by setting aside sufficient funds for emergency use. This can be achieved through the following steps:
1. Deduce the average monthly expenses based on historical spending patterns.
The average monthly expenses should cover both the basic indispensable expenses and the discretionary expenses.
Basic expenses represent the minimum level of expenses that are necessary. These include expenses on food, transport, utilities, healthcare costs and other necessities purchases. On the other hand, discretionary expenses are expenses incurred for human wants. For this category of expenses, we should self-impose an expenditure price ceiling to limit how much we can afford to splurge on to satisfy our wants.
The first step to good personal financial planning is to begin keeping track of our everyday expenditure.
2. Evaluate whether the historical spending patterns are sustainable
Once we start keeping track of our expenses, we are then able to assess if our spending patterns are sustainable and aligned with our retirement goals. Setting and keeping to a disciplined budget facilitates and inculcates a sound habit leading to early retirement.
The 50-30-20 rule is a popular rule that is widely applied by many. It was first made famous by Elizabeth Warren in her New York Times bestseller book “All Your Worth: The Ultimate Lifetime Money Plan”. The original 50-30-20 rule reinforces the idea of spending 50% of the after-tax income on Needs, 30% on Wants and saving the remaining 20% in bank accounts or putting into investments. People soon worked on this rule and created variations to the rule that fits their lifestyle best.
As a general guide, you may consider apportioning 50% of the take-home salary for the non-discretionary and discretionary expenditure, while investing 30% and saving the remaining 20% in the bank.
Within the 50% portion, we can further set out a proportion split for the discretionary and non-discretionary spendings which vary with individuals.
The 20% component that goes into the savings in the bank is known as the emergency fund. Emergency funds are funds saved for the rainy days and unexpected events such as unforeseen medical incidents or sudden loss of employment. The rule of thumb is to ensure at least 6 months’ worth of expenses are maintained in the form of liquid cash. If we follow this reasoning and the 50-30-20 rule, we would be able to accumulate 6 months’ worth of emergency funds within 15 months.
Since we have already accumulated 6 months’ worth of emergency funds, do we still have to continue with the 20% savings in the 50-30-20 rule for future salaries? There is no model answer to this. It really depends on the individual’s preference and comfort level. You may choose to continue with the 50-30-20 rule or to increase the allocation proportion to investment purposes.
3. Re-visit your allocation plan regularly
The 50-30-20 rule is not a stagnant plan. It can be adapted to suit the lifestyle of each individual. The allocation proportion can fluctuate as it should change to align with your current stage of life. A newlywed may have to increase the 50% component while reducing the 30% investment component. Likewise, an adult into his 20 years of marriage may find it easy to gradually increase his allocation to investment as he had already incurred the hefty expenses for marriage in earlier years. The financial circumstances of each individual are different but we should seek to let our money work harder for us once we have less financial commitments.
Furthermore, the proportion depends on the income level of the individual. It may not be an easy feat for someone at the lower income bracket to spend only 50% of his monthly income given that there is a minimum level of basic expenses that have to be incurred. Similarly, the marginal propensity to invest should increase with increasing income levels.
To sum up, the key lies not within whether you hit the minimum level of capital to start investing. Rather, the core essence is whether you have a well-thought out allocation and budgeting plan to ensure your money is put to its best use. It is important to follow a disciplined allocation of your monthly salary. There is no definite or fixed way of allocation. Once you have devised a plan that works best for yourself, you have discerned the amount that you can put into investing.