Figuring out how much to invest is actually a matter of answering the question, how much money do I need?
That’s because committing your money to investments comes with a catch: If you find yourself needing to pull your money out early to pay for bills or unexpected events, there is a high chance of that happening during a periodic downturn of the market. Not only will you lose money, but you will also lose any chances of gaining a return over the long term. We avoid these scenarios with a crucial step before making our first investment – which we’ll come to soon.
We can visualize someone’s wealth by imagining it as four pots. The first pot is their iron reserve – a “safety net” of cash. The second is their pension. The third is for investments. And the fourth is for aspirational investments – opportunities that are of higher risk but may lead to a dramatic change in life.
In order to decide how much to put into our third (investment) pot, we must first understand how much is in the first two.
The first pot is what we call the “Emergency Pot” or “Cash Reserve”. We use this pot to make sure we have enough money to cover our regular expenses and daily lives, as well as a safety net that will take care of any unexpected expenses.
The money in your second pot includes your pension assets and, if you are working, your second pillar. Your pension fund is an investment itself – managed by other people on your behalf. But this shows that you’re already investing, and the leap to making your own investment decisions is closer than you’d think.
After calculating a cash reserve and making sure you have enough to cover your living expenses and anything unexpected, you can consider committing the remaining money to investments (your third pot). This is logical because you shouldn’t need to access this remaining cash for a long time and you’re unlikely to get large returns by leaving it in a savings account (In Switzerland, you can consider yourself lucky if you have a savings account paying an annual interest rate higher than 0.15%!).
Once you’ve started and are considering how much to invest on a regular basis, it’s easy to allocate a portion of your monthly income to investments.
To conclude, there’s the fourth pot. This pot is optional, but we find it exciting to allocate a small amount for riskier (and sometimes exotic) investments.
As we talk about at length in The Masterclass, there’s one more important factor to consider as you decide on how much you’ll invest.
Your appetite for risk must be taken seriously. If you’re likely to feel anxious about a large proportion of your wealth being tied up in investments, it’s not the right approach for you. However, you may be able to work around this with tactics like building an extra-large cash safety net.
Let’s move to the next question: When should you invest?