“How much should you invest?” Investing after all comes with an inherent risk due the accepted volatility of markets, so a sensible cash reserve should always be retained.
Whilst most investment portfolios will give you an indication of how much volatility to expect, how can you manage your own expectation and investment journey? Hopefully the following steps and simple diagram below will help:
First. Hold an emergency fund, completely separate from the investment exercise. Keep this in cash. Perhaps a figure of £ 20,000, others suggest 4-6 months expenditure. Calculate what is right for you. Bear in mind any insurances you have that protect your earned income.
Then consider what you will spend over the next twelve months. Deduct your expected income and hold the residual in your current account. This balance will of course deplete to zero over the course of the next twelve months – if it doesn’t you may need to adjust your expenditure expectations.
Build on the above and look forward. What expenditure do you know will occur in the next 3-4 years. A holiday, new car or a revamp of the kitchen. Keep this accumulative balance in a timed/term deposit account.
For short term expenditure cash is king. Whilst the real value of cash is eroded by inflation each year, at least the capital value is maintained.
Finally. With the remaining capital you are now ready to invest. Be warned there will always be volatility. Some days you will be up, others you will be down.
Remember: Markets will not offer a personal apology for negative returns.
By establishing a healthy cash balance you have effectively created a buffer between ‘you’ and ‘investment risk’, allowing the investment to do what it (sometimes) does.
The discipline comes with maintaining this balance. If the investment makes a loss, just roll one of the term deposit accounts forward. If the investment makes a profit, consider slicing the growth and restocking your cash holdings.
Voila!
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