Most people start their mutual funds investment journey backwards. They pick a random amount, usually whatever feels comfortable that month, and start a SIP without much more thought than that. A better approach starts somewhere else entirely. Rather, it begins with a goal, a number and a deadline. Then, you work your way back working out exactly what steps will be followed month by month.
Start With the Goal, Not the Number
A house down payment, a child’s education, or retirement all demand very different monthly commitments. It doesn’t pay to select a random number at first, and then hope for a payoff later. Rather use your funds to pay for something specific. Work out what this aim will cost you by reaching it, taking into consideration inflation in between. Only after that becomes clear does a monthly mutual funds investment number start to make real sense.
How the Fifty Thirty Twenty Split Works
A common method for dividing monthly income into three parts is by quartering the income. Often monthly income is split into three equal parts, known as quartering the income. 50% pays for expenses such as rent, food and bills. Thirty percent goes toward wants, things like entertainment and eating out. The remaining 20 per cent is saved and invested. This division will not be exactly right for everybody but provides a helpful starting point. Anyone unsure where their mutual funds investment budget should even begin can use this as a rough first pass before refining it further.
Where a SIP Calculator Actually Helps
Working backward from a goal gets much easier with the right tool. A SIP calculator provides you with a goal and duration and helps you calculate the approximate amount you should need to contribute every month. By running a few different scenarios, making only minor adjustments to the time frame and/or the target amount each time, you’ll often find out just how sensitive the result is to minor changes. For example, if one person starts 5 years before they might have to pay a significantly lower monthly installment to achieve the same outcome.
Time Horizon Changes Everything
A goal ten years away can absorb more short term volatility than one arriving next year. That difference should shape where the money actually goes. Longer horizons generally allow a heavier tilt toward equity, since there is more time to recover from a downturn. Goals arriving within a year or two usually call for something steadier, since there is little room left to wait out a bad stretch. Risk tolerance and time horizon should go hand-in-hand and not be separated.
Keep Room for the Unexpected
Before locking money into a longer plan, a few things deserve attention first. Most investments yield a higher return than high interest debt, which is especially true of credit card debt. Typically, paying off the debt first is a better idea than beginning anew investment with the debt. An emergency fund matters just as much, since without one, an unexpected expense often forces an early exit from investments that were meant to run much longer. These two components have to be sorted out first, and then it will be much more durable to invest in mutual funds later on.
This doesn’t have to be flawless the first day. Reviewing the numbers annually, adjusting the amount that is saved based on income changes and rerunning the numbers occasionally, keeps the plan on track over time.
