How Much Should I Invest and Where?

Ah, yes. The question on the minds of everyone who’s interested in building their wealth.

“How much should I invest?”

Sadly, that question does not have a definitive answer, but in the same way that “which diet is the best” doesn’t have a definitive answer: it depends on your specific personal goals.

Still, most people are building their wealth for the same few reasons:

• Retirement
• Passing on wealth to the next generation
• Financial freedom
• Lavish lifestyle

Among similar pursuits.

But there are too many moving parts in the finance world to keep track of if you aren’t an investment junkie. Investment vehicles, various investment strategies, rules of thumb, laws/regulations, and a whole lot of personal opinion.

So we’re going to shine some light on these different aspects of wealth-building so you can make more informed decisions, as well as cover some general advice for how much you should be investing.

Let’s start with the 10% Rule.

Is the 10% Rule Enough?

Not to be confused with another rule by the same name that deals with advanced finance topics, The 10% Rule states that 10% of all your income should be invested in order to build wealth or in other words, retire.

This rule works great as a broad guideline if you are just getting into investing for retirement and/or don’t really know your goals yet.

Beyond the beginning of your investment efforts, this rule tends to fail. Everyone has a different life situation that will call for different levels of investing.

For example, if you’re raking in multiple 6-figures and making use of it with a lavish lifestyle, you’ll need to save a whole lot more than 10% if you want to maintain a similar lifestyle when you retire.

The 10% Rule is an even worse idea if you’re a late starter. We can assure you that investing 10% of your income starting at age 50 will not build enough wealth to sustain a very long retirement.

As always, the best way to determine how much you need to invest is to work with a financial advisor.

Types of Investments

If you really wanted to, you could spend hours gathering every kind of investment in existence.

But that just gets confusing and it overally wouldn’t be a great use of your time, so we gathered some of the most common investment vehicles people use to build their wealth.

Stocks

Stocks are investments into specific companies. They are split into tiny pieces called “shares”, which are essentially tiny slivers of the company that you can buy. For most stocks, you build your wealth through the stock appreciating (increasing) in value over a long period of time.

The stock market can earn you great returns that beat inflation and build wealth, but the downside is that stocks can also depreciate in value. Companies can even go out of business after you’ve invested in them!

If this happens, your money’s gone.

The overall health of the stock market is generally estimated using the S&P 500, a stock index that tracks 500 of the largest US companies by market capitalization (the total market value of the company, calculated by multiplying share price by total shares outstanding).

It’s used this way because the stocks it tracks span a wide range of industries.

Moving on…

Dividend-paying stocks are a great way to build your wealth thanks to the power of compounding.

These companies are focused less on growth, so they invest less of the profits back into their business. Instead, they reward their shareholders with a distribution called a dividend that’s paid out proportionally to how many shares you own.

When you invest these dividends back into their source, you’ll earn a higher dividend the next time, and the effect compounds into retirement. Once you retire, you’ll hopefully have built up enough of an investment to live mostly off the dividend payments.

Mutual Funds

Mutual funds are suited to the investor who cares less about stock choice and wants someone else to handle their investment for them. They’re great if you want many types of assets without thinking too hard.

These types of funds pool the money from several investors. The money pool is managed by the fund’s professional investment manager, who invests the funds into assets like stocks and bonds.

These types of investment funds lay out a specific strategy they adhere to, allowing you to pick one that fits your investing tastes.

To be part of one, you have to pay an annual fee called an “expense ratio” that covers all the admin expense accompanying mutual fund management.

When a mutual fund earns money, you’re paid a distributions proportional to your investment. Mutual funds can also change in value; if the underlying assets increase in value, so will the mutual fund and vice-versa.

Just like with stocks, you can sell your mutual fund holdings if you’d rather take some profits instead of holding on for the long term (or if you’re sick of paying the expense ratio).

ETFs

ETFs are a type of index fund (an investment fund that passively tracks an investment index). However, ETFs are traded on an exchange similar to how you’d trade stock.

This means that you can apply similar investment strategies to ETFs as you would with stocks, unlike other types of investment funds.

Some also pay dividends similar to dividend-paying stocks.

They consist of a bucket of assets, reducing risk as risk is spread among each asset in the bucket.

There are some ETFs that track the S&P 500. Naturally, these ETFs will be a bit more stable in price as they contain shares of the largest companies in the US.

Employer-Sponsored Plans [401(k), 403(b), and more]

Employer-sponsored plans (we’ll shorten this to ESPs) are offered to basically any white-collar worker (and even some “part-time” jobs like retail) at this point.

If your employer offers and ESP and you aren’t using it, you’re missing out on a key way to save for retirement.

ESP contributions are tax-free, and you can opt to have your contribution taken straight from your paycheck to put your investing on autopilot. You’ll be taxed on withdrawals once you crack that ESP open in retirement.

Speaking of investing, contributions are managed by a fund manager. There are several categories of investments, each with various investment options. However, these options can be limited.

Most employers offer a “match” up to a certain amount on their ESP plan, which is basically free money. For every dollar you contribute up to a specified amount, your employer will contribute some amount of money, usually a dollar (although some plans unfortunately don’t offer a 1:1 match).

Again, you’re missing out on free money if you refuse to use an ESP.

Retirement Accounts

Retirement accounts outside of employer-sponsored plans include traditional and Roth IRAs, as well as various sub-versions of those two accounts.

Both of these account types are tax-advantaged, albeit in different ways.

Traditional IRA contributions aren’t taxed, but you’re taxed on your withdrawals in retirement. This helps maximize your current principal and leverage the time value of money, but changing tax laws and your own tax bracket could make these disadvantageous.

Roth IRAs flip the script. You’re taxed on contributions, but you get to withdraw your funds tax-free. So although Uncle Sam takes some of your money now, the rest of it has a chance to grow. When you’re reunited with your money, Uncle Sam keeps his hands off.

Those aren’t the only differences, just the most prominent ones. A financial advisor could help you decide which one makes more sense.

Whichever one you choose, know that your contributions are limited to a few thousand per year depending on various factors.

These accounts provide a solid addition to your wealth-building, but you can by no means rely on them alone.

It’s Up To You

You can read tons of personal finance books, understand investments, learn the investing rules of thumb…

But everyone has a different situation and different goals. One person could get by investing only a small amount of their paycheck from their first job to retirement, while someone else might throw every leftover dollar into investments in a valiant effort to retire early.

And then there’s everyone in between.

Ultimately, it’s up to you to determine how much you should invest.

What we can tell you is if you want to grow your wealth faster and better ensure a secure retirement, you may need to invest much more than 10% of your income.

It’s better to be prepared for the worst and not need the money than to run out of money while you’re still around.

But as we love to recommend, meet with a financial advisor to iron out the details. It is their career, after all.