HOW MUCH MONEY DO I NEED TO INVEST?
100 minus your age rule
One of the first basic questions you face when you start investing is: how much money should I be investing?
The “100 minus your age” rule is a good rule-of-thumb to use for this question. It tells you what portion of your wealth should be in aggressive investments and what portion should be kept in safe investments.
For example, if you are 40 years old the “100 minus your age” rule would have you place 60% of your capital in more riskier investments (such as Forex Trading, stock market, cryptocurrencies, or commodities), while placing 40% of your capital in safer “risk-free” assets (such as Government bonds and cash).
The reason your age is so important is because aggressive investments mean volatility. If you’re in your 30s losing half or more of your capital (for example if you invested in Bitcoin in 2018) – while painful – will not be distratorous as you have plenty of investing years ahead of you to return back to profit. However, losing a large proportion of your lifetime accumulated wealth in your 60s, for instance by investing in risky aggressive investments, should be avoided at all costs.
Many financial advisers advocate updating the rule to “110” or even “120 minus your age.” There are two reasons for this. First, life expectancy has been steadily growing and many people are now expected to live (and keep investing) well past their 80th birthday. Second, the “risk-free” returns on securities like US Government bonds have plummeted from double-digit returns in the 1980s to a pathetic 0.67% return in 2020 – well below the real-life inflation. So the value of the money in your safe, “risk free” investment pot is actually shrinking over time not growing. This is one reason the US stock market has been on such a tear in the past decade: baby boomers (the wealthiest generation on the planet, controlling more than 50% of world's wealth) have no choice but to keep investing in stocks as they age and get near retirement since the alternatives shrink their wealth.
But I’m digressing. Let's backtrack a bit and start from the beginning as you can only use the 100 minus your age rule (or 120 minus your age) if you have money to invest. First you need to make a plan of action to be in a position to invest and grow your money for a better feature for you and your family.
How to find capital for investing?
STEP 1 – GET RID OF EXPENSIVE DEBT.
There is no point investing if you have expensive debts. You simply will not be able to get a bigger return on your investments if your extensive debts eat up all the gains you make on your investments.
If you have expensive debt – credit card debt, pay-day loans, some car loans, basically anything where you pay more than 10% interest – get it sorted before even considering investing. If you don't get it sorted now, it will keep burning a whole in your wealth generation plan for years to come.
If you need help to pay off the debt, talk with your bank or lender. Most of the time they are accommodative and will help you to make a plan to pay off your debt.
Top tip – you can often transfer your credit card debt to a different lender and get a 0% interest rate for a grace period of 6 months or more.
Just to clarify: your mortgage does not count as an expensive debt.
STEP 2 – SAVE FOR A RAINY DAY.
You cannot objectively invest your money in the markets if you constantly have to worry about your bills, rent or how to pay for a broken car or fridge.
Any money you invest should be for growing and generating your wealth – not to be used to pay your bills.
How much money you save for your rainy day fund depends on your circumstances. Are you single or with a family you need to support? How safe is your job? 1-2 months of your salary saved in your rainy day fund might be enough for a single person. If you have a family you might feel safer if you have at least 3-4 months of your salary saved.
The global pandemic in 2020 means the job security and business survivorship are in question. With restaurants, bars and clubs closed, holidays and events cancelled, Zoom calls replacing personal meetings and the need to travel, this is a perfect time to save money for your rainy-day fund (and investments for that matter).
The best way to save money is to automate it. Create a direct debit from your current account to a separate account (rainy day fund) on the day you get your salary. Call it “me tax” and set at least 10% of your salary going to your rainy day fund. If you’re serious about your wealth generation and want to start investing ASAP then you can easily save 20-30% of your capital now that the world is in a lockdown and many of your usual expenditures are not happening. Then in 12 months’ time you will be in a good position to move to step 3 – creating a wealth generation plan.
It might sound like a lot of work: getting rid of debt, saving for a rainy day. For some people this can take a couple of years. But these first two steps are essential. I have yet to see a rich investor or a trader who is not good with his finances. The people who struggle with investing and trading are the people who have not done the first two steps. You cannot build a house until you have laid solid concrete foundations.
STEP 3 – CREATE A WEALTH GENERATION PLAN.
Once you have gotten rid of your expensive debt and saved enough money for your rainy day fund you’re now ready for investing and wealth generation (hurray!).
The monthly direct debit you set up to pay for your rainy day fund you will now move to your investment account and start multiplying this money through forex trading, spread-betting, crypto investing, stock market investing and other aggressive investments.
Here you will use the 100 minus your age rule, or the 120 minus your age rule if you are OK with more risk (and volatility) and think that you will live past your 80s. Allocate part of your investment capital to safe assets (the Safe pot) and part into aggressive investments (the Aggressive pot).
Again, the rainy day fund is not included in the money you use for investments and trading: it’s an entirely separate portion of your finances.
Safe pot
Government bonds – used to be great when you could get double-digit returns.
Cash (no physical cash, of course, but money in a bank account or savings account you can access quickly) – it also used to be great when you could get high single-digit returns by just holding your money in your savings account. Sadly, those days are long gone. The reason you want to keep part of your investment capital in cash is A) it is safe and does not lose value (excluding inflation). B) you can take advantage of any investment opportunities that may come up in the future.
Personally, I’m not bothered with Government bonds; 0.67% return does not excite me. I just keep a proportion of my investing capital in cash to take advantage of any new investment opportunities that may come up.
Aggressive investments
Forex trading (spread-betting)
Crypto investing
Stock investing
Commodities (maybe: this is still more like insurance than investment)
Investing in businesses
Property (some would say it is safe to invest in property but I don't think anything that can drop by 50% in value can be considered “safe”)
Basically anything that has high potential but is also high risk.
Forex trading is my favourite investment vehicle not least because it is tax-free (in the UK and Ireland). Successful forex trading requires the most amount of knowledge and time – but the rewards are limitless. One of the main features I love about Forex trading is margin: the ability to trade much larger position sizes than the capital you invest.
For example with 30:1 leverage you can deposit £10,000 with your broker yet open positions as big as £300,000 (3 lots). The leverage is a double-edged sword and should only be used by experienced traders. Done correctly, it can supercharge your investments.
How to do it correctly:
Let's say you have saved £50,000 for your investments (above your rainy day fund), you’re 40 years old and will use the 120 minus your age rule.
This means you would:
Keep £10,000 (20%) in cash for future investment opportunities.
And invest the other £40,000 (80%) in:
£10,000 in Cryptocurrencies (Stay with top cryptos such as Bitcoin and Ethereum)
£10,000 in Stock market (your favourite stocks or just an ETF that tracks the US index)
£10,000 in Commodities such as silver and gold
£10,000 in your trading account.
Because you have leverage on your Forex trading account and can trade on margin you can use the whole £40,000 of your aggressive pot to trade.
For example, if your positive expectancy trading strategy alerts you to place a 1% risk trade – you would place the 1% risk on the whole £40,000 pot, or £400 risk on the trade. Not 1% of the £10,000 that you have deposited in your trading account.
Using this strategy means that:
A) you can make trading returns on the whole of your aggressive investment capital
B) your investment capital is not just sitting doing nothing while you are waiting for a trade. It is actually bringing you returns from Cryptocurrencies, the Stock market and Commodities while you use the same capital for trading. It's a double return – you make money on your trading account and you make money on your other aggressive investments (Cryptos, Stocks, Commodities).
Remember that the capital you invest in your trading account is not the capital you trade with, but it is only used to pay for the margin requirements – you trade the whole aggressive pot.
Happy Investing and Trading!