How Much of Your Salary Should You Invest In Mutual Funds?

Mutual funds are one of the few buzzing investment options these days. Millennials are turning towards mutual funds as they get a much-needed flexibility of investing a small amount frequently. After knowing that you can invest in small amounts, the next question that arises is “how much of my salary should be invested in mutual funds?” We have covered the following in this article:

50:30:20 Rule

Every earning individual should mandatorily implement the rule of 50:30:20 in their financial plan. This is very important, especially for breadwinners. Implementing this rule will ensure that their future is bright. The 50:30:20 rule says that 50% of your income must be spent on needs, 30% on wants, while the remaining 20% must be utilised to build an emergency corpus.

Needs are those without which you cannot sustain your daily life. These are groceries, house rent or EMI, utilities, and so on. You can never compromise on needs, and you have no choice but to spend on them. Wants are those that are not absolutely necessary, but you are making use of them in order to make your life better. A few examples of these are gym membership, vacation, movie tickets, subscriptions to online streaming sites, and so on. It is advisable for anyone to limit their spending on wants as much as possible.

The remaining 20% of your income must be saved to build an emergency corpus which is at least thrice your monthly salary. Once that is done, you can start investing. Therefore, your investments in mutual funds should be 20% of your monthly salary. If you are able to cut down on spending on wants, then you can utilise the same in increasing your mutual fund investment.

To calculate SIPs easily, use our calculator.

FOIR Application

One can also use FOIR or the Fixed Obligations to Income Ratio, in order to determine monthly investments or SIPs. For example, if your monthly income is INR 50,000 and your fixed expenses like rent or utilities are INR 20,000 then your FOIR is 20,000. So income available to invest is INR 50,000-20,000 i.e. INR 30,000. Now you may invest any amount up to INR 30,000 which is left after spending on your wants.

Importance of Investing in Mutual Funds

Millennials are investing in mutual funds as they offer much-needed flexibility. One can invest a small amount periodically. However, this is not the only factor that is making mutual funds so popular these days. Mutual funds are one of the few investment vehicles that have the potential to offer inflation-beating returns.

Inflation is something that reduces the worth of your money or investment over time. A product costing Rs 100 today may cost Rs 175 after five years. If your investment doesn’t produce inflation-beating returns, then inflation at the rate of 8% will eat half of it in a period of eight years. The table below shows the impact of inflation (8%) on your investment of Rs 1,00,000:

Therefore, in order to retain and realise the real worth of your investment, it is imperative that you earn inflation-beating returns. The best way to do this is by investing in mutual funds.

Long-Term Planning

Mutual funds can be of great help to plan your future. In fact, the best utilisation of mutual funds happens when you stay invested for an extended period (five years or more). The power of compounding, coupled with a long-term investment horizon gives investors excellent returns in the long run. When the markets are favourable, mutual funds can offer returns in the range of 15% to 18%.

Let’s consider an example of two friends Ram and Sham. Mr Ram starts investing Rs 1,00,000 a year in mutual funds at the age of 25 years. Mr Sham starts investing in the same mutual funds at the age of 35 years. Let’s consider the scheme to be offering an annual interest of 10%. Both Ram and Sham decided to redeem their investment at the age of 58 years. The following table shows the difference in the sum accumulated by Ram and Sham:

Note: The power of compounding enhances the corpus accumulated every year. The numbers in the table above do not show the full calculations.

Conclusion

It is crucial to implement 50:30:20 rule in your financial plan. One should invest at least 20% of their salary in mutual funds and can later increase whenever possible. The effect of inflation has made it essential for investors to look at options such as mutual funds to prevent their investment from losing its value over time.

 

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