How to allocate income to equity – The Thumb rule
After few roller coaster weeks in life back to board!
The first few set of questions I hear from new (and sometimes old too J ) investors are
– Where to Invest
– How much to Invest and how to allocate
– How long to Invest
While two of them might have clear cut answers, Where to invest — in different asset classes – Equity, Real-estate, Bonds, Alternative investments etc. How long to Invest – Preferably long term at least with a horizon of 3 to5 years. Tricky question is how much to Invest and its allocation – There is an entire Industry (wealth management) that runs to answer this question. Let’s break this question in two parts – How much and How to allocate. The simple answer to the first part is you should try to invest most of your earnings. Typically we follow this
Income (I) – Expenses (E) = Investments (In),
Following aboveis incorrect in my view, reason for most of the souls the income is constant expenses are whimsical which makes investments to be random and erratic also you will find with expense oriented mindset poor cousin investment will only get leftovers L
The equation to live and invest by is
Income(I) – Targeted Investments(InT) = Expenditure(E),
following above brings in a lot of discipline to our investments and like with many things in life discipline is key to success in investments as well. If you are earning average income in your profession /work (Check here) than you should be having a target of investing 40 percent of your income monthly if not more. If you earn above average you should invest more and if you earn below average ( like many of IT folks 😉 – no pun intended) even than this percentage should not go below 20 percent of your earnings
Now let’s explore the second part of question how to allocate your savings, Lets simplify our asset classes to Equity (including Mutual funds) , Debt Instruments , precious metals and stones (Gold and diamonds We love them). Some follow a thumb rule for allocation
100 – Age of the person = Investment in equity, Balance in others
Now again I’m not a big fan of thumb rules however the underlying logic behind this thumb rule is correct as you grow older you start investing more in fixed income earning instruments than equities.
I believe our allocation should be based on our perception of risk and doing a quick analysis of our ability and willingness to take risk will help. Ability will be defined by our level of wealth and willingness is how wealthy we perceive ourselves. Without going into detail as there a whole subject on it (Behavioral finance) if you are too overwhelmed by the concept of ability and willingness to take risk stick to thumb rule. However if you really want to understand and reach good allocation ( See a professional wealth manager) just know in general the more your ability and willingness to take the more allocation will be risky equities and vice versa.
How much you invest and what percentage you allocate to equities ( my favorite asset class) share in comments!!
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Safal Niveshak – One stop for rookie investors