You’ve reached the point where you know you want to become an investor, but you’re not sure what percentage of your income you should target for investment. How much is too little and how much is too much? You don’t want to wait too long to start building wealth, but you are still somewhat hesitant to jump in given your current responsibilities and life’s inevitable uncertainties.
Calculating Fixed Versus Variable Expenses
In order to calculate how much discretionary income you have available to invest, you will need to conduct a careful review of your savings and determine how much you have in readily available reserves to carry you through a period of unemployment or illness. Think of this as your rainy-day fund to cover fixed expenses when life throws you a curveball. Fixed expenses do not fluctuate much, are paid on a regular basis (often monthly) and include items such as rent or mortgage payments, HOA fees, car payments, insurance, certain utilities and basic groceries. Variable expenses, on the other hand, are discretionary expenses that you typically have more control over – items such as clothing, entertainment, travel, gifts and eating out.
A healthy savings account should have enough cash to cover at least six months of fixed expenses plus additional money for unexpected car repairs, essential home repairs, etc. If you do not already have non-retirement savings in an amount sufficient to keep you afloat for six months, putting that fund together should be your first order of address. The same principle holds true if you have own investment real estate. A reserve fund is necessary to cover the cost of leaking roofs, unanticipated tenant turnover and any number of other scenarios that can (and will) inevitably occur at some point.
Assess Your Risk Tolerance
Once you have your rainy-day savings in place, it’s time to assess your risk tolerance. Are you a born gambler, someone who is willing to undertake reasonable risk after doing some research, or do you avoid risk whenever possible? There are no right or wrong answers when measuring risk tolerance. It’s just important to know where you fall on the spectrum.
Armed with a detailed understanding of your income and expenses, a savings account to carry you over troubled waters and an understanding of your personal risk tolerance profile, you will be ready to invest. While experts advise targeting 10-15% of your gross income for investment, the decision is a personal one that has a lot to do with your goals. How interested are you in the idea of using investment income to generate more income to build personal wealth? Investment income is a direct route to the kind of lifestyle that so many of us dream about in a world where diligent savings is often simply not enough to achieve certain goals.
Low-Risk Starter Investments
Canada’s TFSA (Tax Free Savings Account) program is available to all individuals 18 or older and allows you to put tax-free money aside throughout your lifetime. It’s a great place to start for new investors. As of 2019, the annual contribution limit, indexed to inflation, is $6,000. Unlike an RRSP (Registered Retirement Savings Plan) that is specifically designed for retirement savings, a TFSA can be used for any reason and withdrawals will never be taxed. While you cannot hold actual real property in a TFSA, you can hold stocks, bonds, mutual funds, REITs and interests held through real estate crowdfunding platforms such as IMBY.
While it is important to target a percentage of your income for investment and aim to hit that target as often as possible, it is even more important to get into the habit of saving and investing at an early age – the earlier the better. When it comes to successful investing, time (and the magic of compounded interest) will be your best friend. Get started soon!