What's a Safe Amount to Invest ?

Whenever someone decides to take the leap into investing, they usually have 3 questions:

1. What should I invest in ?

2. How much should I invest ?

And, the dreaded:

3. Is it safe ?

The question of “safety” usually centers around the investment itself (“Bitcoin is not safe, it’s volatile!”) and risk tolerance (How much risk can the investor bear) which is very subjective.

We’ve all met people with low risk tolerance who are terrified of losing money, so they keep it in a safe low return asset (ex: bank account). The risk is not hitting their financial goals at retirement (due to low returns).

And, we’ve met people with high risk tolerance who end up investing in overly risky assets.

Risk capacity injects objectivity into the decision process:

Risk tolerance: an individuals’ psychological willingness or comfort level with risk and potential losses (subjective) 

Risk capacity: their financial ability to endure potential losses without jeopardizing their financial goals (objective). 

Basically:

Risk Capacity sets an upper limit to how much you can invest and in how risky an asset.

Risk Tolerance will determine the level of risk you are willing to take within that upper limit.

For example: Your Risk capacity might be to invest $1,000 per month into a high risk asset and $1,000 into a medium risk one.

But, due to your Risk tolerance you might invest $500 into high risk and $1,500 in medium risk.

So how do you determine your Risk Capacity?

1. Establish Your "Worst-Case" Safety Net 🛡️

The first step is to protect the money you absolutely cannot afford to lose. This money must not be invested in risky assets. It is your "ultra low risk" fund.

• Emergency Fund: At least 3-6 months of living expenses should be immediately liquid (cash or a high-yield savings account).

• Near-Term Needs: Any money you will need in the next 1–3 years (e.g., a down payment on a house, a child's first tuition payment, or a planned large purchase). 

The cash left over after accounting for these needs is your potential Risk capacity.

2. Assess Your Financial Resilience ⏳

Financial resilience is primarily determined by your time horizon and income stability. The longer you have until you need the money, the greater your capacity to absorb a loss and wait for the market to recover.

• Long/Short Time Horizon: If you are saving for retirement 25 years away, your Risk Capacity is high because you have decades to recover from downturns. If you’re closer to retirement, not so much.

• Income/Career: Do you have a stable income ? Do you have multiple incomes ? Do you save monthly ? Do you have job security ? All of these increase your capacity, as you can continue saving even after a market loss.

Assessing your Worst-Case safety net and Financial Resilience is a confusing task, leaving many beginners stuck.

To help you cut through the complexity and instantly calculate your true capacity, I've laid out the exact step-by-step framework in my self-paced strategy course: The Busy Beginners' Money Guide to Build Wealth & Spend Guilt-Free.

In just 2 hours, even if you're an absolute beginner, you will:

• Build a sustainable budget

• Master a guilt-free spending system

• Set clear financial goals

• Analyze and align your spending with your Values

Check it out 

3. Define Your End Goal and Required Return 📈

Finally, work backward from your financial goal.

• The Goal: Calculate the total amount you need for your goal (e.g., $1,000,000 for retirement) and the time you have to reach it.

• The Required Return: Determine the minimum annual rate of return you need to hit that target and find an investment allocation that will help you hit your goal.

A Note of Caution

Determining your true Risk Capacity and creating a personalized asset allocation strategy is complex. It involves accounting for future cash flows, inflation, taxes, and other factors. Consulting a professional might be necessary.

The information contained in this newsletter is for general informational purposes only. It should not be construed as financial or investment advice. Please consult a qualified financial advisor before making any investment decisions.