How to Create a Powerful and Effective Investment Budget

investment budget
  • An investment budget separates spending money from money you set aside for investing.

  • Using an investment budget can help you get started toward long-term wealth building.

  • Saving more is the key, but also using powerful tools such as 401(k) plans and low-cost funds.

People who follow an investment budget tend to save more because they’re aware of their financial habits and are more likely to start investing instead of wasting money. 

An investment budget is a central tenet of achieving financial security and prosperity.

When you take the fundamentals of creating a budget and apply that to investing, you’ll be able to spend less and invest more.

A budgeted investment budget will help you in a number of ways:

  • You’ll be able to tell the difference between non-discretionary and discretionary expenses, which in turn will allow you to allocate whatever you have left over for investing purposes.
  • You will understand the principles of investing with a small amount of money. Many would-be investors fall into common pitfalls once they start investing at scale. These are uniform principles that apply to all monetary levels and work whether you have $10 or $10 million.  
  • You will gain the ability to determine the many entry-level investing options out there.

The basis of a regular budget is for you to determine that your expenses are less than your income. By budgeting for an investment plan, you have to see what you can spare after all of these expenses are paid off.

It is important to first consider whether or not you should pay off crippling debt before investing your extra money using an investment budget.

Conversely, just cutting debt is a way of investing in itself. so this is how you begin to build your investment budget.

Start with expenses

Commit these next two terms to memory: 1) Non-discretionary expenses and 2) discretionary.

Non-discretionary expenses covers your essentials. There is no forgoing these expenses. Some can be managed but they will always be there.

These expenses include:

  • Monthly housing cost: rent, mortgages, taxes, insurance
  • Utilities: electricity, water, gas
  • Food: groceries, basics, toiletries
  • Transportation: public transit, car payment, gas, maintenance
  • Clothing
  • Healthcare   

It helps to make a list of these things and write down their individual costs set on a monthly basis.

Say your annual take-home income — the amount in your check after taxes and any other costs are deducted — is $60,000. That’s $5,000 a month.

If you add up all of their expenses and find that non-discretionary expenses are $2,000 a month, you would see that 40% of your income is necessary expenditures.

The rest of the cash is available for investing. Now onto the next class of expenses.

Discretionary expenses includes all expenses that you do not result from your basic needs. This would include your wants, whims and generally things not needed but desired.

  • Social outings
  • Sports tickets or fees
  • Gifts
  • Vacations
  • Impulse spending
  • Eating Out
  • Luxury items

Nobody is going to be able to cut these things out entirely. But understanding where they spending is going and if it is necessary will get you one step closer to a investment budget that works.

Start by adding up the costs of something you buy on a regular basis but might not need to. It could be a few cups of coffee everyday or daily cruise through a fast food drive-thru.

You might be perfectly fine brewing at home or spending an extra minute cooking something to take for lunch. This can add up to thousands of dollars saved over the years, and that’s thousands that could be invested.

Investment budget planning

Now that you know you’ll have money each month for investing, you can either make monthly investments or large investments throughout the year.

For example, you may be able to make one large investment in the equities market through a brokerage account. Or you may decide to wait until your tax return or other stable time to begin to contribute on an ongoing basis with small sums.

Regardless of your approach, it’s important to start with a plan, an investment budget. Once expenses under control it’s time to understand some important investing and budgeting principles.

Careful investment budgeting takes into account surplus money, where your total expenses are less than your income.

No matter what investing strata or income bracket when you start, the first thing should be for you to weigh the difference between current interest payments and potential earnings on investments.

For instance, if you are paying 19% on a credit card it doesn’t matter if you can make 9% on an investment. Pay off the credit card first and fast!

It’s a simple two-step process:

  1. Look up all outstanding loans and credit card balances you have now. Find out the total amount of debt you have and list all of the current interest rates you pay for each balance.
  2. Now compare that to potential interest earned (an investment’s expected annual gain) and calculate if you’d come ahead or not.

Remember, it works both way. If you were to buy a car with a secured zero-interest loan, it wouldn’t make sense to pay off your loan over investing. It’s better in that case to put your money to work.

This is the basic principle of replacing debt with income-producing assets. If you’re going to take on a major debt, ensure that it’s for something that will retain value over the long run.

For example, a family home, necessary education, or investing in your business are forms of large debt worth holding.

Watch out for the hidden expenses that lurk everywhere, such as taxes and investment fees. Being able to get  your year-end taxes in order will be paramount once you start to make more money that will also be taxed. You will need to know taxes and fees paid to file your tax form properly.

All investments are going to have a relative tax implication you should be aware of. Sometimes these taxes can be even be of benefit, such as deductions for losses or business expenses.  

Plan for unexpected financial events by investing money by saving. Nest egg, emergency fund, saving for a rainy day — whatever you want to call it — having cash on hand will help you out in unexpected situations.

Save money to be able to contend with accidents, home or vehicle repairs and natural disasters. Increasing this savings will translate over to your investments by allowing you to stay the course with your process.

Investments should always be looked at as separate entities, as dollars working for you to create more money! Let your emergency fund take care of non-investment related issues.  

Take the time to learn something new about investing everyday. Read anything you can about your investments and start to figure out what kind of investor you are.

Devise an investor persona

Most investors on a budget will fall into one of two camps: active or passive.

That’s not dictated by age but preference, for how comfortable you are investing money and taking risk.

Active investors will go out and learn as much as they can so they can make a larger commitment to their investing endeavors.

That might mean cutting down discretionary expenses tremendously and investing in specific, high-growth equities. Hard work usually pays off in higher returns.

For those who don’t have the time, and that can be a valid reason, passive investing allows for you to make money made on your investment consistently with less effort. This usually means in index funds or exchange-traded funds (ETFs) that track the major financial markets.

It’s also a great way to earn a solid, long-term market return. This is no small accomplishment.

The reality is that the majority of naive and new investors will lose money. Investing passively on a budget can allay fears that man new, inexperienced investors face.    

Investment options on a budget

Once you’ve decided to put your money to work, there are a lot of investments to choose from. No matter what the dollar amount, one thing will always stay true – put your money into an asset which you think will generate returns in the future on a consistent basis.   

Investing on a budget requires a set of skills and strategies that slightly differs from putting large investment sums on the line. Some of them are actually more accessible to somebody on a budget.

Use a workplace plan: Many employers offer a 401(k) plan and spending accounts for other medical and dental expenses. Make sure you’re contributing as best as you can so that you’re accruing money for retirement on a budget while reducing your current income tax bill.

Some companies offer retirement plans that match to a 401(k). They’ll add a percentage of the employee’s contributions.

For example, if you contribute $4,000 on a yearly basis, then the employer might match that with an additional $4,000.

This makes the 401(k) plan one of the easiest ways to invest on a budget. Additionally, these plans offer tax advantages over regular brokerage accounts.

Invest in ETFs: Consider investing in a passive fund. The average annual return of the S&P 500 Index is 9.8%. It’s difficult to beat that if you don’t have the time to study individual equities.

Investing in an ETF allows you to push the responsibility elsewhere, at least for a little bit while you build your investment.

Low-fee asset pools such as ETFs also allow you to invest in a wide variety of industries and even different kinds of assets. It’s always smart to do your due-diligence beforehand, however.

Keep a level head when investing and try to avoid emotional triggers that will stop you from realizing your fullest investment gains.  

If you want to stay passive, it’s best to invest in accounts that diversify by owning the market so you don’t have to. Just make sure to continually contribute in some manner.

Budgeting your savings for investments: Money takes a lot of time to earn, spending it … not so much. If you can create an expense-cutting plan, you should also be able to sort out a savings plan to get the money to invest with!

Even if you were only to put aside $1 a day, you’d come out with $365 a year. If you’re having trouble building up enough investment money you can use services that automatically save for you.

For instance, there are mobile apps and banking initiatives that automatically round up spending linked to a credit or debit card.

The app then puts that money into low-cost ETF portfolios that you can choose. Acorns for example, charges $1 a month until your balance reaches $5,000.  

Although these types of apps can be unnecessary middleman they’re great for someone lacking the funds or know-how to get going.

Your bank, too, can slowly take out a dedicated amount of savings into another account that can be eventually converted into an investment account.

Smart tips for your investment budget

Debts need to be paid, expenses must be analyzed and the money that you set aside needs to be placed in interest-generating accounts and assets.

There are of course a lot of caveats and financial divots you’ll come across along the way. But the path is there if you can follow it.

Here are some additional things you can do to turn your budgeted surplus into an investment.

  • If you get a tax refund, treat it and any other windfalls as investment money. Never pour “found money” into discretionary spending like most people do.
  • Pay off your debts! This cannot be stressed enough. Debts weigh down your finances and stopping you from living well, let alone investing.
  • Invest in your education. A higher paying job usually outweigh the cost of a college degree, assuming you don’t load up on student debt.

Ultimately, investing on a budget is about using your money in a wise manner so you’ll have more than when you started.

You can save and invest big with a small budget. Sometimes that’s the best way to go.

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