How much of your salary should you invest in mutual funds
It is important to implement the 50:30:20 rule in your financial plan
Young earners tend to spend more and save less thinking that they have no goals and have plenty of years for their retirement. Just because they are single with reasonable financial independence doesn’t mean that they should invest less. Being in your 20s or 30s is the best time to plan for financial independence. Not only young earners, all breadwinners need to invest some part of their salary in mutual funds. Now, how much should that be? Here are a few answers.
What’s the thumb rule of investing?
The general thumb rule of investing in mutual funds is to put at least 10% of your monthly income in a mutual fund. You can do this using a systematic investment plan (SIP) if you are just starting to invest in mutual funds. This is applicable to all those who are able to save at least 20% or more of their income. Initially, before investing you need to build an emergency fund using the savings. Once you have this in place, you can start an SIP with about 10% of your savings a month, which you can increase as you go along. Where did the thumb rule come from?
This comes from the 50:30:20 rule. Senator Elizabeth Warren popularized this rule in her book, All Your Worth: The Ultimate Lifetime Money Plan. Every earning member of the family should mandatorily implement this rule in their financial plan. The 50:30:20 rule says that you should save at least 50% of your income for your needs, 30% of your income can be spent on wants, while the remaining 20% must be used to save and invest.
How does the 50:30:20 rule work?
Needs are those expenses that are necessary for survival and need to be paid every month without fail. These include your groceries, house rent or Equated Monthly Instalment (EMI) for home loan, utilities, and so on. You cannot be without paying these bills for your family and yourself. There is no way you can compromise on needs. Note that these don’t include expenses for movies, dining out and other non-essential expenses. Most of the time 50% of your salary goes towards these expenses. However, if you are able to make do with lesser money then, you can save more. If you are spending more than this, you need to cut down on the expenses.
Wants are those that are not absolutely necessary for running your household. These are just the expenditures that help make your life better. For instance, going to the gym or eating out at the restaurant. You can exercise at home and cook at home to cut down on these expenses. Wants also include your vacations, movie outings, subscriptions to online streaming sites, and so on. It is best to limit the spending on wants to 30% of your salary or lesser than that.
You must save the remaining 20% of your income. You can do this by making investments. You can invest in mutual funds based on your risk profile. Therefore, your investments in mutual funds should be at least 10% of your monthly salary. If you can cut down the spending on wants, then you can use that money in increasing your mutual fund investment.
Why invest in mutual funds?
A large population in India is investing in mutual funds as they offer the much-needed flexibility in terms of minimum investment and ease of investing. You can easily invest in mutual funds online with just Rs. 500 per month. You can get a variety of funds based on your risk profile. For instance, you can invest in debt funds if you have a low risk profile and equity funds are best suited for young earners who are investing for the long run. Mutual funds are one of the few investments that have the potential to offer inflation-beating returns.
If you didn’t know, inflation can reduce the worth of your money or investment over time. If your investment doesn’t provide inflation-beating returns, your savings will get reduced in the long run. For instance, the value of Rs. 1,00,000 will be worth Rs. 1.6 lakhs 10 years down the line if the inflation is 5%. If your investment is earning less than 5%, the value of your money will be negative. If you invest in mutual funds that give you more than 11.25%, your investments will be worth Rs. Rs. 2.9 lakhs. So, if you want to make wealth, you need to invest in mutual funds that provide inflation beating returns. The effect of inflation has made it essential for investors to invest in mutual funds to prevent their investment from losing its value over time.
How to start investing in mutual funds?
You can start with a simple, balanced portfolio of 3-4 mutual funds. For a long-term portfolio, you can invest equally in four funds that are large cap, diversified, index fund and debt fund. Overall, this can be a 70-30 portfolio with 70% in equity.
It is important to implement the 50:30:20 rule in your financial plan and invest at least 10% of your salary in mutual funds. You can step it up whenever possible. Need help? Get in touch with your wealth expert at wealthzi.com.