How to prepare a budget for investing in ASX shares

Here's how to prepare a budget to help you invest in ASX shares.

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

In a recent series of articles I looked at how to prepare for a recession whilst investing in ASX shares. A key component of this was working out and understanding your cash flow needs. In other words, preparing a budget. Preparing a budget is important in the good times and even more so in the tough times.

How to make a budget

Preparing a budget can be as simple or complex as you want to make it. There are some great templates and calculators out there if you want to keep it simple. But when investing in ASX shares, there are a few more factors to consider.

Make sure that you factor the following into your budget: needs vs wants; emergency fund deposits; annual expenses; and amounts for saving and investing.

Opportunity cost

A key concept when preparing a budget for ASX investing is opportunity cost. A dollar spent on a consumable item like coffee is gone forever. However, it may not just be a dollar. If that dollar was able to be invested in ASX stocks and earn a 10% return, it would be worth double in 7.2 years.

It could be worth even more if invested in market beating companies like Altium Limited (ASX: ALU) or CSL Limited (ASX: CSL).

This isn't the only way that each dollar can be different. A dollar saved is worth more than a dollar earned. Why? Because of the tax man. If your taxable income is more than $180,000, you are on the top marginal tax rate of 47% (including the Medicare Levy). Saving $1,000 is the equivalent of earning $1,887 before tax.  

Margin of safety

Everyone will at a minimum know someone who has seen their income impacted by COVID-19. This is a great example of why you need to have a margin of safety built into your budget. A margin of safety is a buffer of how much your income can drop before you "break even" on your necessary spending.

Although COVID-19 is a black swan event, there are many instances where you may see a spike in expenses or drop in income. Your employer could go bankrupt, a family member could have a health issue or you may want to change career.

A margin of safety will allow you to hold your stocks through an unforeseen event, ensuring that you don't miss out on the handful of amazing days that generate most of the stock markets returns. If you were forced to sell Afterpay Ltd (ASX: APT) at the bottom on 23 March, you would have missed out on the 147% rebound through to Easter.

A margin of safety is even more important where you have collateralised debt (such as a mortgage) or any high interest or high penalty amounts owing. Keeping your house and avoiding unnecessary costs can be critical to preserving your wealth in a recession.

Lloyd Prout owns shares in Altium Limited and expresses his own opinions. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. The Motley Fool Australia owns shares of Altium. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on How to invest

A business person holds a big balloon in front of their face.
How to invest

I'm fine with a stock market crash. You might be too

This article might leave you longing for a ride to the downside.

Read more »

Humorous child with homemade money-making machine.
How to invest

How I'd fill an empty ASX share portfolio to build a $500 monthly passive income machine

Building an ASX passive income portfolio simpler than you may think.

Read more »

A smiling woman with a handful of $100 notes, indicating strong dividend payments
How to invest

How to realistically turn a $7,000 ASX share portfolio into $75,000 by 2030

The Australian share market is a great place to grow your wealth. Over the years, countless Aussies have constructed ASX…

Read more »

Happy young couple saving money in piggy bank.
How to invest

4 steps to becoming rich with ASX stocks

These are the steps I would take to grow my wealth materially.

Read more »

Person with a handful of Australian dollar notes, symbolising dividends.
Investing Strategies

Want cash like Warren? How to stack paper without ditching ASX shares

Life is about trade offs.

Read more »

five people in colourful blow up tubes in a resort style pool gather and smile in a relaxed holiday picture.
Dividend Investing

5 simple steps to earning $500 in monthly ASX passive income

Almost any investor can build a $500 monthly passive income from ASX dividend shares.

Read more »

A businesswoman on the phone is shocked as she looks at her watch, she's running out of time.
How to invest

How timing the market can cost you big dollars

And one simple way ASX investors can avoid the urge...

Read more »

Legendary share market investing expert and owner of Berkshire Hathaway Warren Buffett
How to invest

5 easy ways to invest like Warren Buffett with ASX shares

Here’s how we can imitate Warren Buffett with ASX shares.

Read more »