How Much Should I Invest?

Determining the right amount to invest means understanding your own financial situation. Before diving into investments, it's crucial to establish a strong financial foundation. This means having an emergency fund that covers three to six months of your living expenses, which can provide you security, and ensures you won't need to liquidate investments at inopportune times due to unexpected costs.

As a general rule, most investment advisors recommend investing up to 10-20% of your income, but obviously this will vary on your own income and expenses. Only invest with the money you have left over after spending for the essentials: your home, food, and utilities.

For beginners to investing, especially in Japan where the terminology might be different than your home country, starting with even a modest amount like ¥5,000-10,000 monthly can be valuable. This approach allows you to learn about the investment process and develop good habits without taking on too much risk.

How Often Should I Invest?

Rather than trying to pick the perfect moment to invest, which even professional investors struggle to do consistently, consider adopting a systematic approach known as dollar-cost averaging. This strategy involves investing a fixed amount at regular intervals, regardless of market conditions.

For example, most people working in Japan align their investment frequency with their salary schedule, as it makes the most practical sense. If you receive your salary monthly, setting up a monthly investment schedule creates a natural rhythm that's easy to maintain.

Let's look at a practical example. The chart below shows the power of dollar cost averaging - the line in blue represents the Asset Price (ie, the investment you're making). As the months go on you can see it goes up and down in value. If you were to invest each month in this asset, the line in green represents the average price you would have paid over time.

Risk and Reward Basics

Understanding the relationship between risk and reward is fundamental to successful investing. This relationship is on a scale: on one end, you have investments that offer high potential returns but come with greater uncertainty; on the other end, you have more stable investments that typically provide lower returns.

Low-Risk Investments

Government / large corporate bonds and bank deposits represent the lower-risk end, offering modest but relatively stable returns. These investments aren't particularly attractive, especially in Japan where the rates are often sub-1%. These are best suited to people who need access to the money in the relatively short-term, like those saving money for the downpayment on a house.

Medium-Risk Investments

Moving up the risk scale, you'll find investments like mutual funds, index funds, and ETFs (exchange traded funds). These investments basically hold hundreds or thousands of individual stocks inside of them, and diversify their holdings across many different countries and sectors. This makes them less prone to the individual fluctuations that individual stocks might experience, while providing a solid potential return.

High-Risk Investments

At the higher-risk end of the spectrum, you'll find investments like individual stocks. Because these are prone to large fluctuations up and down depending on the companies performance and other external factors, investing in these can be akin to gambling for those who are not investment professionals.

How Can I Assess My Risk Tolerance?

Your personal risk tolerance is an important consideration when investing. One of the most significant factors is your investment timeline. Think of this as planning a journey: if you're planning a short trip, you'll likely want to take safer, more established routes. Similarly, if you need your investment money within a few years, you might want to focus on more stable investments. However, if you're planning for a destination decades away, like retirement, you can afford to take some detours and explore more ambitious paths, as you'll have time to recover from any setbacks.

Beyond your timeline, your risk tolerance is influenced by your current financial situation. Consider factors like your job stability, any debt you're carrying, and your family obligations. Someone with a stable government job, minimal debt, and adequate insurance coverage might feel comfortable taking on more investment risk than someone with variable income or significant financial obligations.

What is a Realistic Investment Return?

Setting realistic expectations for investment returns is important for long-term success. The global stock market has historically provided average annual returns of about 7-10%, including dividends, over the long term. While it's true that past performance don't equal future returns, understanding historical trends helps investors make informed decisions and avoid unrealistic goals, such as expecting consistent outperformance of the market or quick wealth accumulation.

You might hear from so-called "investment professionals", or online influencers that they can acheive higher returns, and while that may be true in the short-term, over the long-term there has been no proven method to outperform the market. Additionally, the funds offered by these people often come with extremely high or hidden fees, further eroding away your investment.