When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
Tips for setting up an investment budget
Investing only as and when you feel like it is no way to reach your financial goals. Drawing up an investment budget will help get you on the right track.
QUOTE
“There are dreamers and there are planners; the planners make their dreams come true.”
Big ideas
- A simple investment budget definition is how much you invest every month, regardless of the state of the stock market on budget day, momentary changes in your levels of income and spending, and how optimistic you happen to be feeling.
- You don’t need to ask yourself “Is investment worth it?” every single time. Having a dedicated stock market budget forces you to pursue your investment goals month after month.
- An effective investment budget will take brokerage and other fees into account. Minimising fees and utilising your monthly stock budget effectively might require you to look into new investment platforms and techniques.
A budgeting definition in the context of investing
Presumably, you already have a household budget. This allows you to balance your income and expenses with something left over at the end of the month.
You could use this surplus in a number of ways. You might spend it on luxuries over and above those included in your budget, save it for a particular goal, or invest it. Doing the latter – adding a clear stock budget item to your monthly spending plan – does mean that you’ll have less free cash at your disposal. The financial rewards of investing consistently are long-term.
These are all reasons why investment is necessary. The more complicated part is actually taking action on a regular basis to achieve these goals. This is why having a defined stock budget is such a good idea.
You could use this surplus in a number of ways. You might spend it on luxuries over and above those included in your budget, save it for a particular goal, or invest it. Doing the latter – adding a clear stock budget item to your monthly spending plan – does mean that you’ll have less free cash at your disposal. The financial rewards of investing consistently are long-term.
These are all reasons why investment is necessary. The more complicated part is actually taking action on a regular basis to achieve these goals. This is why having a defined stock budget is such a good idea.
DEFINITION
An investment budget is a fixed sum you choose to apply towards investments every month, including any brokerage and other fees.
It’s recommended that you start investing only once you have several months’ living expenses saved up and cleared the bulk of your high-interest debt. Once this is done, though, you should settle on an amount that you will invest each and every month.
This should be low enough for you to afford, bearing in mind that investments can’t always be cashed out quickly without taking a loss. Yet it should also be high enough to make a significant difference to your future financial health, and be aligned with the overall goals you’ve set for yourself.
Some people employ the 50/30/20 rule of budgeting that divides your monthly income into three categories:
This should be low enough for you to afford, bearing in mind that investments can’t always be cashed out quickly without taking a loss. Yet it should also be high enough to make a significant difference to your future financial health, and be aligned with the overall goals you’ve set for yourself.
Some people employ the 50/30/20 rule of budgeting that divides your monthly income into three categories:
While the 50/30/20 rule may work for some, others swear by a 50/40/10 approach, which calls for a more aggressive strategy. This method allots 50% for necessities, devoting 40% for investments, savings and debt repayment, and leaving only 10% for discretionary spending.
How having an investment budget benefits you
Advice like “invest regularly” can easily seem more than a little trite and clichéd. This doesn’t alter the fact that it works, partly due to the following reasons:
Psychological motivation. Financial well-being is typically the end result of not one brilliant decision, but a myriad of individually insignificant actions. None of us can make good choices all the time, though. Deciding once and for all to invest a portion of every month’s earnings without fail creates a constructive habit without taxing your willpower every time.
Smoothing out market volatility. It’s a given that share prices, as well as the value of other kinds of investments, fluctuate. Timing the market and somehow figuring out which budget stocks to buy for a song is theoretically possible, but generally a mug’s game. When you invest only a little at a time, the value of your portfolio is less exposed to short-term market fluctuations.
Convenience. Especially when you’re just starting out, it’s quite hard to figure out what to do with your investment budget. Examples include deciding on a risk profile, translating this into a mixture of bonds and stocks, or selecting an ETF…perhaps even considering other risky alternative investments. Once you’ve decided on a stock budget and set up the necessary structures, by contrast, you can mostly forget about these vexing details.
Relating investment budgets to financial goals
We suggested that the amount you choose to regularly invest shouldn’t be so high as to leave you strapped for cash each month, yet it can’t be so low as to make no practical difference. This provides a useful starting point but doesn’t quite give us a specific number.
Instead of just buying as much stock as you think you can afford, it makes sense to place your monthly investment budget in the context of a broader financial plan. This means setting specific goals. Here are some investment spending examples that may give you a better idea of how small monthly investments add up to long-term success:
Meet Jack:
He’s self-employed, 40 years old, and wants to retire to the countryside in 25 years. For this, he estimates that he’ll need £2,000,000 to buy a cottage and take out an annuity to cover his living expenses. Since Jack has some time left to achieve his goals, he can afford to ride out the ups and downs of the market. He chooses to invest his money in shares rather than more stable but less lucrative investments. Given that, historically, the FTSE 100 yields average total returns of about 7.8% per year, Jack needs a stock budget of £2,172 per month to meet this goal.
Instead of just buying as much stock as you think you can afford, it makes sense to place your monthly investment budget in the context of a broader financial plan. This means setting specific goals. Here are some investment spending examples that may give you a better idea of how small monthly investments add up to long-term success:
Meet Jack:
He’s self-employed, 40 years old, and wants to retire to the countryside in 25 years. For this, he estimates that he’ll need £2,000,000 to buy a cottage and take out an annuity to cover his living expenses. Since Jack has some time left to achieve his goals, he can afford to ride out the ups and downs of the market. He chooses to invest his money in shares rather than more stable but less lucrative investments. Given that, historically, the FTSE 100 yields average total returns of about 7.8% per year, Jack needs a stock budget of £2,172 per month to meet this goal.
Year | 1 | 5 | 10 | 15 | 20 | 25 |
Investment | £27,021 | £158,784 | £393,009 | £738,517 | £1,248,182 | £2,000,000 |
Note that the returns on his investments are significant – he will have invested “only” £651,684 during the course of these 25 years. Still, two thousand pounds per month is more than most people can afford.
Jane’s position is somewhat different:
At 55 years of age, she has £300,000 saved up and plans to retire in 10 years with at least £500,000. Since this doesn’t give her much time to recover from a recession or major upset in the stock market, she invests in bond products instead. These yield a virtually guaranteed return of 3.75% per annum, meaning that she needs to put away £467 each month to reach her goal.
Jane’s position is somewhat different:
At 55 years of age, she has £300,000 saved up and plans to retire in 10 years with at least £500,000. Since this doesn’t give her much time to recover from a recession or major upset in the stock market, she invests in bond products instead. These yield a virtually guaranteed return of 3.75% per annum, meaning that she needs to put away £467 each month to reach her goal.
Year | 1 | 4 | 7 | 10 |
Investment | £316,852 | £371,296 | £432,098 | £500,000 |
Since she’s started investing relatively late and can’t take on much short-term risk, compound interest doesn’t help her as much as it does Jake. Still, her low-budget investment of only £56,023 in total did net her a cool £200,000, thanks largely to having a lump sum to start with.
Finally, let’s take a look at John:
Having just celebrated his 20th birthday, he’s unsure of where he’ll be working next month, never mind his retirement plans. He does know that he’d like to own his own business someday. Now, ideally, goals should be both measurable and quantifiable, unlike John’s.
Any final number he came up with at this point would be no more than a guess, though. He is, however, willing to commit to investing £100 every month come rain or shine. He chooses a low-cost mutual fund with an average yearly return of 6%.
Finally, let’s take a look at John:
Having just celebrated his 20th birthday, he’s unsure of where he’ll be working next month, never mind his retirement plans. He does know that he’d like to own his own business someday. Now, ideally, goals should be both measurable and quantifiable, unlike John’s.
Any final number he came up with at this point would be no more than a guess, though. He is, however, willing to commit to investing £100 every month come rain or shine. He chooses a low-cost mutual fund with an average yearly return of 6%.
Year | 1 | 5 | 15 | 20 | 25 | 30 |
Investment | £1,227 | £6,937 | £16,280 | £28,864 | £45,813 | £68,640 |
These figures are nothing to sneeze at, though John would have done better had he increased his monthly investments as his income rose.
The examples presented are for illustrative purposes only and should not be construed as investment advice or recommendations.
There are several calculators online you can use to generate figures reflecting your own circumstances. As we’ve just seen, an investment strategy based on recurring monthly additions starts to bear fruit when your reinvested payments attract interest. It’s therefore wise to begin as soon as possible and contribute as much as you can to your investment fund.
The examples presented are for illustrative purposes only and should not be construed as investment advice or recommendations.
There are several calculators online you can use to generate figures reflecting your own circumstances. As we’ve just seen, an investment strategy based on recurring monthly additions starts to bear fruit when your reinvested payments attract interest. It’s therefore wise to begin as soon as possible and contribute as much as you can to your investment fund.
Where to invest small sums every month
Thinking back to our stock budget definition, you’ll remember that transaction fees make up a chunk of the total. We’d like to keep this expense as small as possible: if you invest £100 each month, but your brokerage service charges a £5 monthly fee, you’re actually losing money.
Source: TradingExplained.com. The examples are for illustrative purposes only and should not be construed as investment advice.Luckily, thanks in no small part to digital technology, there are several investment products that cater precisely to people who’d like to start investing according to a budget. Let’s take these in the order of simplest to most complicated:
1. Savings accounts
Assuming that you already have a current account with a bank or building society, you may as well ask them what savings account options they offer. If you find their terms acceptable, you can then set up a monthly direct debit for the day after you receive your salary.
This option is very straightforward to implement. However, there are some things to keep in mind:
This option is very straightforward to implement. However, there are some things to keep in mind:
- Savings accounts are very safe – you’ll never get back less than what you put in. However, their interest rates aren’t great, with 3% to 6% being about the best you can expect.
- The advertised interest rate may only apply to the first year you have the account or to existing customers at that bank. In most cases, this rate fluctuates along with the “base rate” set by the Bank of England or the respective central bank of your country.
- Most savings accounts come with certain terms and conditions attached. Be sure to look at restrictions such as how much you can save each month and how quickly you can access your money in an emergency.
You could see savings accounts as a kind of introduction to investing. The money you save each month won’t grow much and may not even keep up with inflation. On the other hand, savings accounts are also painless to set up and manage. You’ll have relatively easy access to your money should you need it to deal with an emergency, too.
DEFINITION
Inflation, specifically consumer price inflation, refers to how much the cost of living rises each year. If your investment returns aren’t at least as high, your nest egg is actually losing value even if the monetary amount continues to grow.
2. ISAs (Individual Savings Accounts)
ISAs are a British innovation; many other countries have similar investment vehicles. Like with ordinary savings accounts, most people will not need to pay any tax on the interest they earn on their ISA. Many banks and other financial institutions, including Trading 212 offer ISAs. The account is easy to open and then you can contribute to it every month. They come in two basic flavours: cash and investment ISAs. Some things to be aware of:
- Deposits into cash ISAs are insured just like those in savings accounts. An investment ISAs value, by contrast, is determined by that of the “basket” of securities the ISA invests in. This means that you can earn a higher return, but that your investment may also go down in value.
- The government limits how much you can put into an ISA while still enjoying the tax benefits. Currently, this figure stands at £20,000 per year (as of April 2023).
- There are different kinds of ISAs. Some are riskier than others in the short term, but also perform better on average. In general, you can move your funds from one ISA to another once per tax year without any penalties.
In short, ISAs are a step up from simple savings accounts, and most accept automatic monthly direct debits. They’re less flexible, though: if you feel that you may need quick access to your money, you should read their terms and conditions carefully.
3. Mutual funds & ETFs
Investing directly in shares and bonds - two common types of investments - normally require more capital than investing in mutual funds. Mutual funds are simply investment products that allow multiple small investors to pool their funds in order to gain access to high-profile securities. Some things to know about mutual funds, including ETFs (Exchange Traded Funds), are:
- You could see mutual funds as a kind of budget stock market. Though you won’t have to select individual investments yourself, your portfolio can lose value if the market takes a dip.
- Many mutual funds accept direct debit transfers of as low as £25 per month.
- Different mutual funds have different risk profiles. Accepting higher volatility usually means greater returns in the long run.
- Most funds charge management fees of under 1% of your total investment every year.
- Other fees may also apply, for instance, if you withdraw your investment before a certain amount of time has elapsed.
Make use of investment apps
One characteristic of all of the options above share is that they’re primarily passive. Aside from the original decision to start investing regularly, you don’t really have to do much of anything.
Should you be willing to learn a little about investing and take greater control of your portfolio, you can also use any of a number of online and mobile platforms. Some of them offer practically the same range of services as a real brokerage. Many allow you to invest in ETFs, bonds, and stocks with the tap of a few buttons. A bit of caution is advised when using these, though, for the following reasons:
Should you be willing to learn a little about investing and take greater control of your portfolio, you can also use any of a number of online and mobile platforms. Some of them offer practically the same range of services as a real brokerage. Many allow you to invest in ETFs, bonds, and stocks with the tap of a few buttons. A bit of caution is advised when using these, though, for the following reasons:
- Most of these apps are regulated by the Financial Conduct Authority (in the U.K.) or another appropriate government body. It doesn’t hurt to make sure of this, but even so, you may prefer the solidity a bank or other well-known financial institution offers.
- Many investment apps can supply you with advice based on the state of the market and what they know about your personal finances. Robo-advisors don’t yet have the same insight and experience as certified financial planners.
- Trading in stocks, foreign currencies, and exotic investments like NFTs can be a huge rush and even a little addictive. If you do choose to use one of these apps, make sure not to risk more than your allocated budget for investment each month.
Recap
Not everyone has a substantial lump sum to invest. This doesn’t matter, though: by investing a little at a time but frequently, you can still get on the investment ladder and start building your financial future.
One way of making this easier is to set aside a monthly investment budget. By creating an automatic direct debit to deposit this into an investment of your choice, you remove the self-discipline needed to save from the equation and ensure that you’ll be investing diligently from now on.
One way of making this easier is to set aside a monthly investment budget. By creating an automatic direct debit to deposit this into an investment of your choice, you remove the self-discipline needed to save from the equation and ensure that you’ll be investing diligently from now on.
FAQ
Q: How much should I invest each month?
There is no universal answer that’s applicable to all people. Some popular guidelines range from 10% to as much as 25% of your income after tax. A good look at your household budget, listing your necessary and optional expenses, should give you an idea of how much of an investment budget you can afford without affecting your lifestyle.
Q: When should I start using a monthly investment budget?
Investing in the future is a great idea, but you should also take your present circumstances into account. While investments gradually earn you money, debt constantly takes it away. You should, therefore only start investing every month once your high-interest debt, like outstanding credit card balances, has been paid off.
Q: How do I know whether my monthly investment strategy is working?
Checking the value of your mutual fund or other investments every day is likely to get you all worked up over nothing. Small, temporary movements in share prices can easily seem like either the end of the world or the beginning of a new era. Life-changing returns on investment (ROI) happen over the long term thanks to compound interest and the growth of the economy.
You can align your investment goals to match your circumstances, like Jack, Jane and John in the examples above. After that, the best policy is just to keep setting money aside, reevaluating your investment options and rolling 5-year investment performance every so often to make sure they are meeting your expectations.
You can align your investment goals to match your circumstances, like Jack, Jane and John in the examples above. After that, the best policy is just to keep setting money aside, reevaluating your investment options and rolling 5-year investment performance every so often to make sure they are meeting your expectations.
How to create a dividend portfolio?
What is dollar cost averaging?
Is investing small amounts worth it?
