Written by: Antwon Weary
What Percentage of My Income Should I Invest
Remember the early years of your life when you would stash away all the money that you got from birthdays or the Tooth Fairy? Back then, many of us weren’t concerned about investing for retirement savings, debt repayment, or living expenses, but now, many of us are in a similar dilemma: what percentage of my income should I invest?
I remember the great joy of waking up and finding that $5 bill under my pillow that the Tooth Fairy would leave me in exchange for my (not-so-brushed) tooth. I would take that $5 bill and any other money I got throughout the year, and stash it all in the top-right corner of my underwear drawer where, as a young and naïve child, I thought no one could find it.
From a very young age, I was a saver. Now some people may have done the same and others may have taken that money and spent it right away on shoes, bubble gum, or trading cards. Those people were spenders.
So how do we find this middle ground?
What is income?
First, we need to define what our income is. Our income is the combined earned income from all sources of employment. This would include your W-2 and/or 1099 gross income for the year.
Once we have this number in mind, we can use that as a starting point in deciding how much or what percentage of these dollars we want to set aside to invest and save for retirement.
How Does Saving Relate to Investing?
In this article, we will be discussing retirement savings and the items you should keep in mind for funds set aside for your future. Based on your age and retirement goals, these retirement savings dollars will be invested in the stock market.
Those dollars that I left in my piggy bank for years actually lost purchasing power due to inflation (cost of goods and service increasing over time).
With our retirement savings dollars, we will want those funds invested as the stock market has historically outpaced inflation over any long-term time span in US history.
Prioritizing Spending vs. Investing
The below list outlines how we prioritize spending vs. investing and the ways to use tax-advantaged investment accounts for your retirement savings.
1) Pay Yourself First
A common concept I encourage my clients to do is to pay themselves first. You work hard for your money, it’s yours!
If you’re a doctor who sacrificed years of your life training, why should someone else get your hard-earned money before you? I encourage my clients to put themselves first for the hard work and accomplishments they’ve achieved.
So yes, this means focusing on saving for your future-self first!
From there, we can pay for the other things in life, like paying Netflix for your subscription or 24-Hour Fitness for your membership.
Now part of the savings conversation boils down to investing. One important question we need to ask ourselves is when will our future self-need this money? Chances are the money won’t be needed for another 15-30 years, which is quite a way away!
For money that we set aside to be earmarked with a long-time horizon, or long time in the future, we want to make sure we can, at a minimum, maintain our purchasing power, which is our ability to purchase goods and services.
As we know, the prices of goods and services increases over time due to inflation. Think about that famous $5 footlong from Subway. A few years ago, $5 use to buy you a footlong sandwich from Subway. Now that same $5 probably gets you half a sandwich and a cookie if you’re lucky.
This is where the importance of investing our long-term savings money comes into play. We not only want to maintain our ability to purchase that footlong sandwich and keep up with inflation, but we also need our dollars to grow in excess of inflation for our wealth to accumulate.
Can you lose more what you invest in stocks?
The short answer is yes, there is risk associated with investing. But over a long period of time, you should be able to see a healthy rate of return on your investments in the positive direction.
If history is a basis point for our decision, a globally diversified portfolio has outpaced inflation in any long-term time horizon. If our goal is long-term growth and we invest our dollars appropriately, there will be a strong chance you outpace inflation and accumulate wealth over the long run.
As your dollars begin to grow and we see returns that surpass the rate of inflation, that is when you truly begin to see our wealth accumulate.
2) How Much Do I Save?
Once my clients are motivated to begin saving, I commonly receive the same question: what percentage of my income should I save?
While we’re sitting at that intersection deciding if we should turn left down the savings route or turn right down the spending route, we might stall out and receive a few honks from behind us if we don’t decide in a timely manner.
Luckily your financial advisor isn’t going to blow their horn on you for making a wrong turn. That’s why we take an easy and simplistic approach to our answer: 20%.
I encourage my clients to, at a minimum, pay themselves 20% of their annual gross income to for retirement. With everything else that comes with your lifestyle, such as paying down debts, home buying, college savings, etc., I encourage my clients to budget their monthly cash flow after budgeting that 20% for retirement savings.
Remember, saving for retirement doesn’t mean you won’t ever see this money again: it’s still your money! You are simply taking some money away from your present self and putting it aside for your future self in retirement.
Now while investing, I mentioned the importance of making sure your dollars are invested in a way that is appropriate for aiming to not only beat inflation, but to grow your wealth. You want to make sure the future version of yourself is happy with the investment decisions that were made, so I suggest reaching out to a professional that is used to handling and managing the investment side of your plan.
3) What Investment Accounts Do I Use?
Now that we know how much to invest, and how to invest these dollars, we need to know where to put those dollars. On the where side, this is talking about which account will give us the biggest tax-advantages. This is a very important aspect of investing and retirement savings.
There are two main categories of investment accounts:
- Formal Retirement Accounts (401k, 403b, Traditional IRA, Roth IRA, etc.)
- Brokerage Account (Individual or Joint Investment Account)
Formal Retirement Accounts
Starting with the formal retirement accounts, these are accounts that receive special tax treatment from the IRS and can be sponsored by your employer (401k, 403b, 457b, etc.) or set up outside an employer like an IRA (Individual Retirement Accounts).
With these accounts, you cannot access the funds without penalty before age 59.5, yet they do offer special tax treatment in the account.
These all offer tax-deferred growth, meaning that you do not pay taxes on the growth in the account year over year.
From there, we have our pre-tax retirement accounts. With these, you get a dollar-for-dollar deduction from your taxable income on the amount you contribute to the account in the year you contribute. Now we know the IRS always gets their slice, so all funds that you withdraw from the account in retirement are taxed as ordinary income.
Next, we have post-tax or also known as Roth retirement accounts. With these, we get no deduction from taxable income from the amount we contribute, yet in retirement, all the funds in these accounts can be withdrawn tax free.
For more details on the differences between these accounts, this article discusses the advantages of tax-deferred formal retirement accounts.
With brokerage accounts, the gains/losses realized in the account (realized meaning when you sell a position for a gain or loss) are subject to capital gains taxes and provisions.
These do not allow for substantial tax advantages as compared to the formal retirement accounts, and in most cases would prefer you invest the maximum amount available to you before investing in a brokerage account.
4) What Accounts do I Use?
With this decision, it is absolutely case-by-case based on numerous factors such as current income, savings, expenses, goals, etc., and I recommend speaking to a financial professional about your personal financial situation.
5) Where Do I Get Help?
Now that we have a solid understanding of how much money we should be saving, how to invest these dollars, and what accounts to use, we want to make sure that the implementation of the investment side of your plan is appropriate for your situation.
As a kid buying Pokémon and baseball cards, that seemed like a great investment! As a professional in your career, you may want to consider additional investment diversification and a personalized investment strategy.
A majority of the clients I work with across the country defer this portion of their plan to a professional. Most physicians or high-income earners simply do not have the time to conduct portfolio research, occasional portfolio rebalancing, keep up with what’s going on in the market, tax loss harvest, etc. If they did have the time, most of them find being with family or getting some extra sleep more appealing than managing an investment portfolio. If you would like to speak with a Finity advisor to discuss your financial situation, feel free to reach out to us at https://thefinitygroup.com/meet-us.
Related Blog Posts:
- What is the Purpose of Tax Deferred Retirement Accounts?
- How Much Money Does a Doctor Need to Retire?
- 6 Tips for Rapid Wealth Accumulation
- Retirement Plans for Doctors
Investing involves the risk of loss, including total loss of principal. This should not be construed as individualized investing advice. Consult with your investment advisor to develop an appropriate investment strategy for your circumstances. This should not be construed as individual tax advice. Consult with your tax professional for specific tax ramifications for your circumstances.