How Much to Invest
Episode #9 of the course Investing money for beginners by Maureen McGuinness
In Lesson 1, you may recall that there were some criteria that should be met before investing. This is because any money you invest is at risk, i.e. you may lose your whole investment. Don’t panic! The aim of this course is to equip you with the foundations for investing and to reduce your chances of losing that investment.
What You Can Afford to Lose
Putting all your eggs in one basket is risky, but investing itself is inherently risky, even with a good asset allocation that doesn’t leave you exposed to one type of market. When you start investing, it’s important to know how much you should begin with. I was a nervous investor because when I started investing, I had no friends or family who had invested in the stock market or peer-to-peer lending. After looking at what assets I already had (mostly cash in low-yielding savings accounts), I asked myself: What amount of money would I be comfortable losing?
You can either choose a percentage of your current savings to invest, e.g. 1% to start, or you could choose a nominal amount, e.g. $100.
The aim is to pick an amount which, if lost, would have little to no impact on your financial security, e.g. you can still keep up bill payments, pay for groceries, make rent or mortgage payments, and cover health costs.
Lump Sum or Monthly Investments
One of the ways of reducing your risk is to invest regularly instead of a lump sum.
If you’ve recently received a windfall, you may be tempted to invest all that money immediately so you can start to receive passive income. While it’s wise to make sure that the money starts working for you, putting it all in the stock market at the same time could be riskier than you realize.
By investing only once into the stock market (this is less applicable to P2P), you have locked yourself into paying one price. The benefit of setting up a monthly investment, especially when investing in the stock market, is that you will benefit from dollar cost averaging, or buying your stock or index fund at different prices. Look at the following example:
Emily sets up a monthly investment to purchase a stock index fund, which tracks the S&P 500.
She decides to invest $100 every month into the index fund. In her first month, $100 buys her 0.5 units in the stock index fund. In the next month, the price of the stock index fund drops, and her $100 investment buys 0.7 units in the stock index fund. In the third month, the price drops again, and her $100 investment buys one unit in the stock index fund.
After three months and $300 of investing, Emily now owns 2.2 units in the stock index fund.
If Emily had instead invested $300 in month one, she would have received 1.5 units in the stock index fund, 0.7 units fewer than if she had spread her investments over three months.
Another benefit of investing monthly is that you don’t have to worry about tying up too much money in your investments. If you want to put that money into something else, you can pause your monthly investments and restart when you feel it’s right.
Now that you’ve learned about types of investments, where to buy investments, and whether you’re aiming for income or growth, tomorrow, we’ll explore diversification—a key strategy for reducing the risk of losing your investment.
Recommended book
Common Sense on Mutual Funds by John C. Bogle
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