Many people invest their money to get the best returns possible, and the financial services industry encourages this (it helps them sell more products). However, within a financial plan, it is essential that investments are designed to support your lifestyle.
The first thing to consider is an emergency fund. The textbooks suggest holding capital equal to three to six months’ income, which can be drawn on at short notice.
However, a more reasonable amount should be what feels comfortable to the individual, giving some consideration to the cost of an emergency that is not insured.
For those in work, I would suggest a minimum of six months’ salary to ensure you can continue to fund your lifestyle should you lose your job. This will give you a comfortable period to find a new job.
After ring-fencing your emergency fund, consider what expenditure above normal income you may require in the next five years.
This money should be invested at a relatively low risk but possibly with a longer notice period. These funds can be used for funding expenses that exceed normal income, such as holidays.
Longer-term funds can be invested to achieve a higher return, depending on your personal risk tolerances, to provide wealth for retirement or fund bucket list expenditures.
Other specific objectives may include children’s weddings, house deposits, or university fees. These need more detailed planning to take into consideration:
- The cost today
- The future value of those costs
- When the money is likely to be required
- Inflation (but there may be a better inflation assumption than the Retail Price Index). For example, education fees often rise at a higher rate than inflation.
Once you know the target value and the assumed rate of return on your investments, you can calculate your savings needs.
If you have a specific budget, you can calculate the required returns and the level of risk you need to take with your investments.
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The Financial Conduct Authority does not regulate Financial Planning.