Tuesday, April 5, 2016

How Much Money You Should be Saving From Your Paycheck

 An older couple leaning against each other on a pier

Investment advisors are fond of saying wealth is not about timing the market, it's about time in the market. Over time, the U.S. stock market has produced more wealth than nearly any other kind of investment. For prudent, and more importantly patient investors, the gradual accumulation of stock equity and a balanced approach to other kinds of investments is the key to both building wealth and successful retirement.

So, how much should the average investor be trying to save in order to retire on time?

The Rule of Three

All other things being equal, the rule of budgeting is to guarantee two-thirds of all available funds will cover necessities, leaving one-third available for discretionary, or non-essential purchases. As heretical as it may sound, retirement savings are not a necessity on a day-to-day basis, so they must come from non-essential sources. The good news is a well-prepared and well-educated investor can bend this rule without actually breaking it.

The Tax Advantage

A standard investment is made with after-tax money. Taxes are paid with essential income out of the first two-thirds, which means any investment made is coming from the other one-third. However, if you buy a tax-advantaged investment, you are able to dip into that first two-thirds of your budget and invest some pre-tax money and some after-tax money. This is vitally important because those pre-tax dollars are a form of cost averaging that will dramatically improve your returns over time.

Interest and Dividend

If your goal is to save for retirement, then reinvestment of your interest and dividends is important. Not only does this give you a second angle for cost averaging, but it also allows your returns to build a positive feedback loop. This option is available with most mutual funds and is a great way to take some of the pressure off your cash positions as you grow your portfolio.

Wealth Projection

Many mutual fund companies offer new investors a way to buy shares at regular intervals in a kind of "installment investing" agreement. Alongside this method of investing over time, they can also provide historical analysis of a mutual fund's performance and project what a certain level of investment would generate if it took place over a pre-selected interval of time.

This allows investors to see how much needs to be invested and for how long in order to obtain the necessary principal levels by a certain date. It is no guarantee of success, but it does give investors a range of options they can evaluate based on their financial situation.

Knowing how much to invest is important. Making sure that investment works for the investor is equally important.

David Milberg is an experienced investment banker who hails from NYC.

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