Whether you’ve just started your first job or are already decades into your career, one of the biggest questions that every adult faces is how much of their income they should be saving.
If you save too little, then you’ll risk having to work until you’re well into your 60s and 70s, or simply no longer able to. But if you save too much, then this will mean having to make a lot more sacrifices in the present.
Additionally, you might have other reasons for saving that goes beyond retirement. These could be other large-scale purchases like a home, vehicles, children, starting a new business, and so much more.
In his post, I’d like to help give you some idea of how to tackle the “how much should I save every month” question with some important points to consider.
Conventional Wisdom Says 10 Percent
For years, the vast majority of financial media outlets and gurus have offered a simple solution: Save 10 percent of your income.
However, it should really be considered as nothing more than a rough, ballpark figure. Experts like to use 10 percent because it follows the Goldilocks syndrome: It’s a reasonable enough amount of money to save without coming across as too extreme or overbearing.
Particularly with retirement savings, the problem with 10 percent is that if you have expectations of working only 25-30 years, a savings rate of 10 percent may not be enough for you to retire upon. Take this simple example:
- Let’s say you earn $60,000 now and would like to have a retirement nest egg that produces about the same amount of annual income.
- Using the 4 Percent Rule, we can estimate that you’d need a nest egg of about $60,000 / 0.04 = $1.5 million.
- Saving 10 percent of your income would mean contributing $6,000 to your nest egg each year.
- If we assume your nest egg will be invested in a mixture of funds that return a net average rate of 7 percent per year, then we can calculate at this savings rate that it will take just over 43 years for you to reach your goal of $1.5 million!
As you can see from the math, this is why the conventional wisdom of 10 percent is often criticized for being too low. If you want to retire in a more timely fashion, then you’re going to need to increase your contribution rate.
The 50/30/20 Rule
Another widely popular savings recommendation comes from Senator Elizabeth Warren. In her book All Your Worth: The Ultimate Lifetime Money Plan, Warren proposes her famous 50/30/20 budget rule. This is a simple plan aimed at helping young people divide up their after-tax income as follows:
- 50 percent towards needs and must-haves (food, shelter, transportation, etc.)
- 30 percent towards wants (eating at restaurants, shopping trips, vacations, etc.)
- 20 percent into savings (retirement, emergency fund, extra payments towards debt principal, etc.)
If you were to use 20 percent as your savings rate for retirement contributions, then this is going to help shave years off of your timeline. Using the same example from above, a savings rate of 20 percent would mean working 34 years instead of 43. That’s going to remove 9 years of employment.
However, it will also come with a cost. A higher savings rate is obviously going to require more cutbacks in your day-to-day spending. You’ll need to mind your budget and ensure that your expenses can accommodate the remaining 80 percent of your income.
What if instead of saving 10 or even 20 percent of your income, you decided to shoot for 50 to 75 percent?
That might sound crazy. But there are lots of people out there who believe in doing this to achieve something called F.I.R.E.
F.I.R.E. stands for “financially independent, retired early”. This is a social movement where the idea is to take control of your financial life by rejecting consumerism and avoiding unnecessary debt.
Though most of the people who F.I.R.E. usually seek to have enough money to quit their day jobs by the time they’re in their 30s and 40s, retirement is not always the priority. Many who strive to F.I.R.E. simply want to be free of financial obligation so that they can pursue other rewarding passions such as traveling, hobbies, or spending more time with loved ones.
Customize Your Savings Rate to Meet Your Financial Goals
As you’re probably noticing, there is no one size fits all recommendation. Every financial situation is unique and should be treated as such. That’s why the best approach to this question is to consider your own goals and then calculate how much money you’ll need to save to get there.
For instance, if separating from work and enjoying a secure retirement is something you’d like to do, then crunch the numbers. Sit down with your spouse and go over a few different scenarios. Determine how much you’d be comfortable saving to achieve a balance between the future and the present.
If you’ve got more immediate goals, then work those into your savings rate too. For example,
- Do you have a large purchase coming up like a wedding or a down payment for a house? You may wish to save an extra 10 to 20 percent on top of your normal monthly savings to cover it.
- Do you have an emergency fund of 3 to 6 months worth of living expenses set aside? If not, you may want to put an extra 5 to 15 percent per month extra towards this goal.
No matter what you’re saving for, going to be nearly impossible to be successful without first understanding your budget. Your budget is your plan for how to spend your income, and it’s also your best mechanism to ensure that you’ll be able to accommodate your financial goals. This is where an app like Buxfer can help.
Buxfer lets you connect to your bank and credit cards and then monitors your spending habits in real-time. You can use it to find out where you might be overspending and could potentially cut out some expenses. Having insights like this could help you to allocate more money towards the things that really matter.
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