What Percent Of Your Income Can Go For Mutual Funds?

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  • 29 Feb 2024
What percent of your income can go for Mutual Funds?

Investing in mutual funds is a smart technique to wealth-generation. Investing small sums regularly is a good habit. But, how much one should save from one’s salary is a difficult question. There are so many books that recommend saving at least 30-40 percent of one’s salary in a fixed deposit. But there is no clear answer on what percentage should be saved with mutual funds.

In this simple guide, let us understand how much one should save or invest every month for a mutual fund. We will understand some strategies that will help generate a bigger wealth corpus.

Understanding Your Personal Financial Landscape

Before diving into mutual fund investments, it's important to understand your current financial situation.

Start by calculating your total income. You can try including all the sources that you are getting your money from. These could be salary, bonuses, rent from your house, and others. Next, you need to outline your monthly expenses. This could include regular costs such as rent, mortgage, utilities, or any existing debts.

For instance, imagine you earn ₹50,000 per month, and your fixed costs and expenses total ₹30,000. This leaves you with ₹20,000 as the amount that can be used for saving. Knowing this surplus is a foundational step. You can now plan on investing a part of this or the whole towards a mutual fund scheme.

Investment Goals

Clearly defining your investment goals is pivotal. Whether it's saving for a down payment on a house, funding your child's education, or building a retirement nest egg, understanding your objectives guides your investment strategy.

Determine the timeframe for each goal—short-term, medium-term, or long-term. Short-term goals, like a vacation in a year, may require a more conservative approach, while long-term goals, such as retirement in 30 years, allow for a more aggressive strategy with higher potential returns.

For example, if your goal is to accumulate a down payment for a home in five years, consider a balanced approach with a mix of equity and debt funds. On the other hand, if retirement is your long-term goal, you might lean more towards equity funds for their growth potential.

Risk Tolerance: A Balancing Act

Once you have identified how much you can save every month to meet your goals, the next step is to find out your risk level. Understanding your risk tolerance is very important because different funds can have different levels of risks. It's important therefore to choose a mutual fund scheme that is less risky than your comfort level.

Consider Mary, who, with a low-risk tolerance, invested heavily in aggressive growth funds, only to panic during market downturns. This example emphasises the need for a balanced approach that considers both potential returns and individual risk tolerance.

Although mutual fund operators clearly explain risks such as market risk, credit risk, and liquidity risk, not every investor understands them. Common mistakes include underestimating risk tolerance, leading to anxiety during market fluctuations, or overestimating it, potentially exposing investors to more risk than they can handle. Evaluating risk tolerance involves assessing your ability to endure potential losses without abandoning your investment strategy.

Optimising Your Allocation Strategy

Once you've assessed your financial landscape, determined your risk tolerance, and set clear investment goals, the next step is optimising your allocation strategy. What percentage of your income should go into mutual funds?

A widely accepted guideline is the 50/30/20 rule. Allocate 50% of your income to necessities, 30% to discretionary spending, and reserve 20% for savings and investments. Within this 20%, your mutual fund allocation can be further optimised based on your risk tolerance and investment goals.

Let's say your disposable income is ₹2,000 per month. Following the 50/30/20 rule, allocate ₹1,000 to necessities, ₹600 to discretionary spending, and reserve ₹400 for savings and investments. Out of this ₹400, you might decide to allocate 70% to mutual funds, amounting to ₹280 monthly.

However, these percentages are not rigid and should be adapted to individual circumstances. Factors like emergency funds, existing investments, and additional savings goals also influence the optimal mutual fund allocation.

Monitoring and Adjusting Your Portfolio

Investing in mutual funds is not a set-it-and-forget-it strategy. Regularly monitor your portfolio's performance, and adjust your allocation as needed based on changes in your financial situation or market conditions.

For example, if your income increases, consider increasing your mutual fund allocation to accelerate wealth growth. Conversely, during economic downturns, reassess your risk tolerance and make adjustments to maintain a balanced and realistic approach.

Common Pitfalls to Avoid

While determining the percentage of your income for mutual funds, beware of common pitfalls:

1.Overlooking Emergency Funds: Allocate a portion of your savings to an emergency fund to cover unexpected expenses. Avoid the temptation to invest all available funds, ensuring financial stability during unforeseen circumstances.

2.Ignoring Diversification: Diversify your mutual fund investments across different sectors and asset classes. This mitigates risk and enhances the potential for stable, long-term returns.

3.Chasing Performance: Avoid chasing past performance. Historical returns do not guarantee future results. Instead, focus on the fund's strategy, management, and alignment with your investment goals.

While personal finance experts generally recommend allocating 25-35 percent of your investments to mutual funds, the exact allocation cannot be done using a one-size-fits-all approach. Understanding how much and in what level one should regularly invest in mutual funds, requires a thoughtful and personalised approach. The process itself considers factors such as financial background, risk tolerance, and investment goals. Good investors try to strike a balance between risk and return and align their goals with their strategy. They also regularly monitor and adjust their portfolio for financial success.

Remember Oscar Wilde's famous saying, everything in moderation including moderation in itself? Well, that may sound philosophical but it holds true even for mutual fund investments. It is great to have a balanced allocation, but then you should periodically review the allocation. And, prepare yourself with changing circumstances, and seeking professional financial advice. Doing so will not only help you with valuable insights but also enable you to grow your wealth. After all, diligence and prudence are such great traits that they help you navigate the world of mutual funds with ease.

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