How much of your income should go toward investing?

In the fable of the ant and the grasshopper, the ant works all summer storing up food so he can be comfortable in the winter. The grasshopper decides he’d rather have fun and spends the summer fiddling.

We all know how that worked out for the grasshopper. 

While great for teaching our children to plan for the future, this fable also paints an oversimplified version of finances.

1. Save everything and put off your enjoyment
2. Spend it all and enjoy the present 

But, when it comes to retirement investments, the truth is neither of those investment strategies is very good for most people. Few want to put off their life until they can retire, and fewer still want to spend their retirement metaphorically freezing. 

The better option is to balance your savings with your spending so you can enjoy your present and your future.

To that end, clients often inquire ‘How much of my hard-earned wage should I carve off for retirement savings?’ 

While we don’t have a simple number for you, we can give you some standard guidelines to follow which will help you balance preparing for your future with enjoying your present.

Two major factors for a balanced financial foundation

If you want to create balance in your finances, you need to focus on two things: your goals and your finances. Once you have those two things sorted out, it becomes much easier to understand which financial options work best for you.

Factor 1: Your goals, i.e. your future

Your investments are about your future. You’re putting away money you could spend today to ensure a better future tomorrow. But, you can only do that when you know what your better future looks like. Otherwise, you’re not funding your retirement, you’re just putting money in investments and hoping.

When you’ve taken the time to create a future goal, you can then:

• Build a financial plan. Once you understand where you want to go, you can start mapping out a plan to get there. This is a vital step for ensuring your savings are building toward your dream.
• Measure your progress. When you have a defined goal, you can see if your actions are getting you closer, and celebrate when they are. This is important to keep up your motivation.

Factor 2: Your finances, i.e. your present 

After you have a clear goal, with a strong financial plan so you can measure your progress, you need to stop and take stock of what you have today. If you’re bringing home $5,000/month and you’ve created a plan to invest $2,500, it’s going to make investing onerous, if not impossible. And then makes your plan less likely to succeed

So, before you commit to a financial plan, take a look at:

• Your income vs. your living expenses: Your cost of living will depend on a great variety of factors, including your family life and even where you live. Take the time to understand how much of your monthly income is eaten up by non-negotiable expenses. Then, once you know how much you need to live each month, you can start to define how much you can save. And, if your income goes up, you can revisit it to see if you can save more.
• Your debt: It’s important that you’re in control of your debt, instead of the other way around. So before you tag your funds for savings, take a look at what you owe, and how it fits into your finances.  Now, by combining your debt maintenance with your non-negotiable expenses, you have an even better idea of how much you have to invest.
• Your emergency savings: No one likes to think of emergencies, but that doesn’t mean they aren’t going to happen to you. By planning ahead for emergencies, you can avoid taking on debt, allowing you to continue your investment plan without interruption. Most financial planners recommend having at least 3-6 months of essential expenses saved. 

Once you have your emergency savings topped up, a plan to pay down debt and a good idea of how much money you have left over after paying for those important living expenses, you will have an idea of how much money you have for discretionary spending and saving.

Rule of thumb

It’s important to do the above work of sorting out your finances, but at the end of it, putting your finger on the right amount can still be confusing. Should you save 50% of that leftover income? Or, can you spend a little more and get that car or home you want?

A good rule of thumb to use when deciding how much to spend or save is the 50-15-5 rule.

It stipulates:

1. 50% of your take-home pay should cover your essential expenses, like: housing, healthcare, food, child care and debt repayment. 
2. 15% of pretax income should get invested for your retirement
3. 5% of take-home pay should be saved for emergencies

This leaves you with 30% of your income to spend on discretionary expenses, like entertainment, travel or lifestyle purchases.

Finding the perfect number for you

Of course, that 15% is not a hard and fast rule. Because you’ve done your homework and figured out your goals and your finances, you can tweak it to fit your life. If you’re making more money, you can top up your savings to ensure your future goals are possible. If, however, you need a little more money in the present to hit a short-term goal and you’ve set yourself up for future success, you may ease off retirement savings.

With the above tools, you have the ability to take your financial future into your hands.