Now, let’s look at the second question — how much of your personal savings you should allocate to the stock market?
In general, I try to invest as much as possible in the stock market because the incredible power of compounding can create so much wealth over the long term.
Every extra dollar you invest wisely in the market today could be worth $5, $10, $20, or more in the future.
However, there are some very important guideline I follow to limit how much I invest in the stock market:
- Never invest so much money that it would risk your financial future.
- Never invest money you’ll need in the next 5–10 years.
- Never invest so much money that you can’t sleep well at night.
Let’s look at each of these in more detail.
Don’t take outsize risks that could bankrupt your financial future.
Yes, the allure of having all your money compounding in the market is tempting. But remember that it’s not unusual for markets to decline by -50% or more in a single year.
And some investors, through either poor investing decisions or bad luck, can lose all their money in the market.
There’s an old saying on Wall Street:
“Bulls make money, bears make money, pigs get slaughtered.”
It means that bulls — investors who think the market is headed up — make money over time.
Bears — investors who think the market is headed down — make money over time.
But pigs — investors who are greedy, impatient, and excessively risky — get slaughtered.
When it comes to stock market investing, it’s not a place to make risky bets. So never invest so much of your savings that a -50% (or more) decline would devastate your financial future.
Or, to use the words of legendary investor Warren Buffet:
“Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”
Another pearl of investing wisdom is never put money in the market that you’ll need soon (typically the next 5–10 years).
There are a few reasons.
First, markets can decline quite a bit during downturns, which would significantly shrink how much money you have available.
For example, let’s say you have $30,000 to invest in the market and you’re planning to buy a new home in two years.
You put your $30,000 into some great value stocks, but a bear market roars and the S&P 500 declines by -60% in two years.
Your value stocks only decline -50% (which is much better than the market), but now you only have $15,000 for a down payment on a home. You may need to put your new home purchase on hold.
This is why investors say you should only invest money in the market that you could see decline by -50% and won’t need to get out anytime soon.
The last thing you want to do is buy high, watch the market decline by -50%, and then take your money out of the market at its lowest point, right before a long and prosperous recovery.
Another reason not to invest money in the market that you’ll need in the coming 5–10 years is you don’t want to be forced to sell out of your positions before you’re ready.
For example, imagine you do a ton of research and invest in a good value stock. To your delight, it goes up 10% and appears to be poised to keep rising.
But because you need the cash for something outside of investing, you’re forced to sell your shares and miss out on potential future gains.
This can also cause you to realize a tax bill on your capital gains sooner than you were expecting.
Bottom line: Don’t invest money in the market that you may need in cash over the next 5–10 years.
This is a simple one.
If you’ve invested so much money in the market that every little pullback and correction keeps you up at night, then you’ve either put too much in or stock market investing may not be right for you.
Now, I’m not suggesting you shouldn’t care about or keep track of your investments. Quite the opposite.
For most new investors, I’d say, “Just get started.”
There’s a lot to learn about investing in the stock market and it’s good to experience some of those early lessons with less money at stake.
More important than how much money you put in today is how much you add over time.
For several reasons, steadily adding to your investments over time is likely to provide a huge boost to your long-term wealth.
So start with what you have today and add more money, positions, and strategies over time based on what you learn and what works best for you.
And remember these key lessons:
- There’s no minimum to get started investing, however you likely need at least $200 — $1,000 to really get started right.
- If you’re starting with less than $1,000, it’s fine to buy just one stock and add more positions over time.
- If you’re starting with a small amount, some brokerages allow you to buy partial shares for just $5 or place free trades.
- I try to invest as much as I can in stocks because every extra dollar I invest wisely today could be worth $5, $10, $20, or more in the future.
- However, never invest money in stocks that you’ll need in cash in the next 5–10 years.
- Never take outsize risks and invest so much money that your overall finances are at risk.