You’re ready to invest and start building your nest egg, but there is just one question you’re trying to figure out: How much money should I invest in stocks? The answer to this question can be tricky because it depends on many factors including your own personal finances, age, and potential retirement lifestyle. Not to worry, we’re going to dive into a few investing concepts below so you’ll be better equipped to decide how much to invest in stocks and other securities.
How Much Money Do I Need to Invest In Stocks?
Myth busters coming through! Contrary to popular belief you do not need to be rolling in the dough in order to start investing in stocks. Thanks to online brokerages and the many investment vehicles offered by these companies you can start investing with as little as $5.
This makes investing even more accessible for young investors and especially women who are more often than men unable to access traditional retirement accounts offered by employers due to taking on unpaid labor like caregiving during their career years.
Instead of laboring to save up hundreds, you can invest in stocks right now. The important takeaway is that you do not stop investing after your first deposit. Generally, you want to be investing at regular intervals over the course of your earning years in order to truly build wealth.
How Much Should I Invest In Stocks As A Beginner?
If you are totally new to the world of investing, you might be experiencing feeling overwhelmed. You’re not alone, so let’s take this one step at a time.
First, Examine Your Finances and Set An Investment Goal
Your first step will be to do a quick review of where you’re at with your money in order to get some perspective. This will help you set your investment goals which will help drive how much you invest in stocks and other securities.
When reviewing your personal finances, the general rule of thumb is that you have the following items taken care of before you start investing:
- You can cover your monthly expenses each month without using a credit card and have some kind of budget or money plan in place
- You’ve paid off all high-interest debt (i.e. credit card debt or anything above 15%)
- You have built an emergency fund. You can decide what is a comfortable amount for you, as money experts recommend anywhere from $1,000 to 6 months worth of expenses.
These should be your first financial priorities before investing because they help protect your finances right now. Investing helps prepare for your financial future, but you’ve got to get the present on the right track and stable before moving money into the stock market.
Once you have these items taken care of you will want to set a personal investment goal. You’ll want this goal to be something that you can consistently meet each month, so this is why it is important to know your personal finances. It could be $50 per month or $600 per month. Review your budget and see how much you can afford to invest each month and then write it down as your investment goal.
Next, Consider These Major Factors When Investing In Stocks
When you’re investing in stocks as a beginner there are some important factors to consider including how you want to invest.
1. The Type of Investor You Want To Be
You’ll want to decide if:
- You want to be picking stocks and making your own investment choices
- Or, if you want to let the ship sail itself and choose a more passive investing option
This decision will impact which stocks you choose to buy and in what containers they live in.
2. The Investment Account That Houses Your Stocks
Speaking of ‘containers’ you’re going to need to decide what type of investment account is right for you before you decide how much you should invest in stocks. Common investment accounts you’ve probably heard of are:
- Roth IRA
- Brokerage account
These accounts are the container that holds your investments. Within these investment accounts, you can choose your investments. This could be individual stocks if you open a brokerage account and identify as the type of investor who wants to pick their own stocks. This could also be an index fund within an IRA if you identified as the investor who does not want the hassle (or the responsibility with research) of picking your own stocks. If you’re brand new to investing and are not sure how much to invest in stocks or where, then the latter may be a better choice.
3. Your Investment Risk Tolerance
All investing carries risk and it’s important for anyone deciding how much to invest in stocks to also understand their risk tolerance.
Risk tolerance is how much loss you’re prepared to weather as you make investments. For example, if you have a low-risk tolerance you probably won’t choose to invest in stocks individually as this carries the most risk of losing on your investment.
Ask yourself, how will you react if you invest and then see your investment drop in value the next day? If you’re already starting to sweat, then you probably have a low-risk tolerance and can choose to invest conservatively.
That said, you will also want to consider your risk capacity. Risk capacity is how much your portfolio can handle risk based on a variety of factors including your investment goals. Basically, it is an estimate of the level of risk your portfolio can withstand versus risk tolerance which is about what you can withstand.
Generally, you’re investing over the long term and not the short term. This means the more time you have in the market, the more risk capacity you have. This is why young investors’ portfolios tend to have more stocks (a riskier investment) and fewer bonds (a less risky investment). As you age, your risk capacity changes because you’re approaching retirement, which is when you need to hold onto and have that money (i.e. you do not want to lose it). If you’re wondering “how much should I invest in stocks for my age now?” we will dive into the general rules below.
4. How Diversified Your Investments Are
Typically you want to build an investment portfolio that is diversified. This means you’re not investing all of your money into the stocks of one company. That would be the opposite of a diversified portfolio.
When you’re deciding how to invest in stocks, you can choose investments that are already diversified. For example, ETFs and index funds are like baskets that hold stocks and securities. These funds track an index like the S&P 500, which is composed of the top 500 companies in the US. This means you’re investing across all those companies and this keeping a diversified investment. As you increase the amount you invest in stocks, you may choose to have a few types of funds that you’re putting money into, further diversifying your portfolio.
How Much Should You Invest In Stocks Monthly?
While your budget should be a consideration for how much you invest in stocks monthly, it’s good to figure out your retirement number than work backward so you have a number to aim for. These are the three steps you can take to determine how much you should be investing in stocks (or other securities) each month.
1. Estimate Your Annual Retirement Income
You’re investing in stocks for your future and over the long term. A key component to finding out how much you should invest in stocks is determining how much you plan to live off each year in retirement.
A common starting place for finding your annual retirement income number is to take 80% of your pre-retirement annual income. For example, if you currently make $75,000 per year, then your annual retirement income estimate would be $60,000.
Once you have this initial estimate you will need to consider:
- Your cost of living for where you plan to live
- If you will have any dependents you need to care for still
- If you will still have debt, including a mortgage
- Your lifestyle (i.e. will you be traveling more and spending more)
Each of these items could mean your annual retirement number needs to increase.
2. Calculate Your Retirement Number
In order to find out how much you should be investing each month, you need to know the end goal. Know that there are multiple ways to estimate your retirement number, below is just one common way to find your number.
4% Rule (AKA 25x Rule): Annual Retirement Income x 25 = Retirement Savings Goal
This general rule of thumb is based on a withdrawal strategy. That simply means how much you plan to take out of your investment accounts each year of retirement. With this formula, it estimates that 4% is how much a potential retiree could take out of their accounts over a 30 year retirement period without running out of funds.
Let’s run the number using the estimated annual retirement income of $60,000 mentioned above.
$60,000 x 25 = $1.5 million
If you just gasped, it’s ok. We know that is a huge chunk of change. But keep in mind you’re not necessarily going to save $1.5 million. You will have the power of compound interest and returns on your side when you’re investing in the market. This means your money will grow without new contributions (but you should still be making them each month).
3. Determine How Much Time You Have To Invest & Use a Retirement Calculator
Lastly, determine how much time you have to invest. Meaning, how old are you and at what age do you plan to retire?
Now, the formula gets a bit harder from here due to inflation, estimated salary increases, anticipated returns prior to retirement and after retirement. This is why we recommend you use a retirement calculator to get your final monthly investment number. You will need to input your age, annual retirement income, how much you currently have saved. Then, you can toggle how much you invest each month until you see your estimated retirement number.
How Much Should You Invest In Stocks According to Your Age
Remember earlier when we talked about diversifying your portfolio and adjusting for risk? That is what we are going to look at more closely now.
Stocks are a more risky investment compared to bonds. This means that as you age how much you should invest in stocks will change to account for your risk capacity.
The general rule of thumb is to subtract your age from 100 and that would be how much you should invest in stocks. According to CNN, as Americans start living longer financial planners say you could subtract your age from 110 to 120 and be left with how much you invest in stocks. This is where your risk tolerance comes into play and personal finance is truly personal for each investor. That said, here is what those numbers look like:
- 20s and 30s: During these years you have the most time in the market and thus can choose to have 70% to 90% invested in stocks.
- 40s: As an in-between age, you can choose to assume more risk with 80-70% invested in stocks or the more traditional balance of 60% invested in stocks.
- 50s: At this point, you are likely going to retire in the next 10 to 15 years, so a more conservative mix of 50% stocks and the rest bonds is common. However, you could choose to keep 60-65% in stocks for a period of this time assuming a bit more risk.
- 60s and Up: As you are nearly at retirement age, your portfolio mix will likely shift to about 50% in stocks depending on your risk tolerance. You will not want to take all of your investments out of stocks since they can continue to grow while in retirement.
These numbers do not account for cash you should already have on hand for emergencies.
Why Invest In Stocks and Take Any Risk At All?
You might be considering why take any risk at all? Why not just keep your investments as safe as possible all the time? It’s a good question and thankfully has a fairly simple answer.
Generally the more risk the higher the returns, meaning your money makes you more money when the risk is higher. If you have time in the market, your portfolio can weather the ups and downs (volatility), meaning you can generally take on more risk. That is why in your 20s and 30s the general rule formula allows for up to 90% invested in stocks. As you age, you’ll balance your portfolio mix, which is how much you invest in stocks vs bonds.
Keep in mind these are not personalized numbers and they do not take into account your own risk tolerance. You should consult a certified financial planner if you’re still not sure how much you should invest in stocks for your age.
Ready to Invest In Stocks? Compare Brokers Below
If you’re ready to invest in stocks outside of your employer offered plans like a 401(k), then take a look at some of the top online brokers below. They offer both individual brokerage accounts and IRAs in addition to a variety of investment options. When you explore the brokerages below and be sure to review fees, initial investment requirements, and how you can choose to invest in stocks (via funds or individually).
Feature Image: Twenty20