Your personal savings rate is not only income or investment income, but also the most important factor in ensuring financial security.
But how much should you save? $50 a month? 50% of salary? Nothing until you pay off your debts or start making more money?
How much should you save each month?
Many sources recommend setting aside 20% of your income each month.
According to the popular 50/30/20 rule, you should reserve 50% of your budget for essentials like rent and food, 30% for discretionary spending, and at least 20% for savings. (The credit for the 50/30/20 rule goes to Senator Elizabeth Warren, who reportedly taught it when she was a bankruptcy professor.)
Read more: 50-30-20 Budget Explained – A Simple Budgeting Method
In general, we agree with the recommendation to save at least 20% of your monthly income. But it’s not always that easy to offer the right percentage of income for YOU to save.
If, for example, you make good money, it would be wise to lower your expenses and set aside a much larger percentage of your income.
On the other hand, if saving 20% of your income seems implausible or even impossible at the moment, we don’t want you to get upset. Keeping something is better than nothing.
But if you want to be safe in old age – and have extra money for what you want – the numbers show that 20% is the goal you want to reach or exceed.
Why 20%?
According to our analysis, if you are between 20 and 30 years old and can earn an average investment return of 5% per yearyou will need to save about 20% of your income to have a chance of becoming financially independent before you are too old to enjoy it.
Here’s the thing: if you want to work like a dog every day until you die, you probably don’t need to save so much. Of course, you still need the occasional vacation and something for a reserve fund in case your car’s radiator coughs.
However, in addition to this, we save so that one day we no longer have to work for money. For most of us, this day will not come in many decades, but there are ordinary working people who reach it as early as 40 or even 35 years old.
Read more: Reserve funds: everything you need to know
What are you saving for?
True financial independence means you have enough money to never have to work again. You can live off your current savings as well as growth, interest or dividends for the rest of your life.
How much money do you need to save up to do this?
Good question. Simple answer: it all depends. It depends on whether you are willing to live below the poverty line, whether you need two houses and a sailboat, or are somewhere in between. It also depends on how well your investment is performing. If you can earn an average annual return of 7% of your money, you can stop working with much less than if you were only earning 3%.
For simplicity, we use the general “The 4% Rule”, which says that in theory you can withdraw 4% of your main balance every year and live on it indefinitely. This means that you will need save 25 times your annual expenses to become financially independent. (If the math doesn’t suit you, remember that 25 x 4 equals 100 and 100% = your total balance).
Of course, there are problems with the 4% rule. First, today there are no risk-free investments, the yield of which would be close to 4%. Sudden inflation can also be a problem.
In addition, if your investment growth exceeds 4%, you are living less than you could, and your account balance is growing every year. This is a big problem, but it means that you are living a lower lifestyle than necessary.
Bottom line: there is risk in everything, and if you adopt a strict 4% withdrawal rate, you may not have enough money…or too much.
I think it’s good to plan around using the idea of taking the 4% off, but then make adjustments as needed when the time is right.
How much time will it take?
The chart below shows how long it will take you to accumulate 25 times your expenses, based on the percentage of your income that you save. (We assume an average annual return of 5%).
| % of income saved | Time needed to save 25x annual costs |
|---|---|
| 5% | 66 years old |
| ten% | 51 years old |
| fifteen% | 43 years |
| twenty% | 37 years |
| 25% | 32 years |
| fifty% | 17 years |
| 75% | 7 years |
| 90% | less than 3 years |
As you can see, by saving 20% of your income, you will increase your annual income by 25 times in 37 years. This means that a 30-year-old who starts saving today (assuming they haven’t saved before) will reach that goal by age 67.
And keep in mind, this only assumes 5% growth. Historically, the stock market has returned far more than this over long periods of time.
The lower your expenses, the faster you will reach your personal savings goal. Because it lowers the overall goal and allows you to save more.
Also, our savings table does not include taxes.
Tax credit accounts can help
For the sake of simplicity, our chart shows the money coming in before taxes, assuming you will pay taxes on the money going out. But tax-protected retirement accounts like 401(k)s and IRAs change the equation for the better.
If you qualify for a Roth IRA, use it! The money you deposit into The Roth IRA is taxable now, but your withdrawals are not taxable when you retire. So the more you save in Roth, the less you will need to save overall because you won’t have to pay taxes on Roth withdrawals when you retire.
401(k) contributions can also help make it easier to reach the 20 percent savings rate, provided you can take advantage of at least a 5 percent match from your employer when you invest in a 401(k). This means that you really only need to save 15% of your paycheck.
Also, if you invest in a 401(k), that money will be deducted from your pre-tax paycheck, which means that every dollar you deduct will save you some money after taxes. But you will pay taxes when you withdraw money for retirement.
Achieving 20% - example
Let’s say you make $1,200 every two weeks. After taxes, that’s $1,000. Your savings goal should be 20% of your net (after tax) income, or $200 from each paycheck.
If you make a pretax 401(k) contribution of 5% of your salary and your employer balances it, that means you’re saving $60 of your pre-tax check (and your employer adds another $60). That’s $120 in your retirement account every month.
You still owe yourself $80. You can put half into a Roth IRA for additional retirement savings and the other half to create an emergency fund. What you do with it is not as important as the fact that you saved it at all.
Between saving before taxes and agreeing with your employer, saving 20% of your paycheck gets a little easier.
Calculate how much you can save:
What if I just can’t save that much?
Don’t stress. Keeping something is better than nothing.
I can already hear screams from the comments: “How funny! I spend almost everything I earn on rent, food, and transportation! This site is not in touch with its audience!”
Good good. If the 20% scenario I just sketched doesn’t fit your situation (which will be unique to you), then please don’t think I’m saying you’re a loser. As I said, we believe that everyone should aim for 20%, not that everyone can reach that goal on the first try.
Start small. Start with 1%. When it doesn’t hurt that much, increase to 2% or even 3%. Maybe you got 5% and that’s not bad. Maybe you make a crazy 10% jump and that leaves you stressed and attached so you cut back. It is a process of literally giving and receiving.
Despite all this, keep the 20% goal in mind. This will save you from complacency. Whenever you get a raise, raise your savings rate! You used to get along just fine without that money, and you shouldn’t miss it if you never get used to it.
Finally, if you are in debt, you may already be saving more than you think. This is because paying off debt is essentially saving in reverse.
Think of it this way: one day you will be free of debt. But you’ve been making large monthly payments on your debts for years. If you suddenly start saving this money, what will be your savings rate?
The trick here is not to replace that car payment or credit card bill when you pay it.
Connected: How to get out of debt on your own
Where should you save?
Where you should be saving your money depends on where you are on your savings journey. If you don’t already have an emergency fund, a high yield savings account (HYSA) is a great place to start one. Easy access is essential in emergencies and you can quickly withdraw money from HYSA. And, unlike most checking accounts, HYSA will, you guessed it, generate high interest income.
Ready to start saving? Compare today’s best savings account rates and discover them today!
Keep in mind that the interest you can earn with a high-yielding savings account pales in comparison to what you can earn in the long run (by saving for retirement, for example) by investing your money.
If you already have an emergency fund (good for you!), then start investing. Your 401(k) form is a great place to start because you can get a match from your employer.
If you don’t have access to a 401(k), consider starting with a robot advisor where the funds you deposit are invested in pre-built diversified portfolios according to your risk tolerance.
Here is a list of robot advisors we recommend.
If you ultimately decide that you need more control over your portfolio, you can switch to an online brokerage where you can make your own trades and build your own portfolio.
I scored 20%. What’s next?
Keep going! As long as you don’t deprive yourself today, it’s hard to save “too much.”
Heed the same advice we gave to those who are struggling to reach 20%: test your limits and try to increase them. Building strength (physical or financial) requires discipline and consistency, and a willingness to listen to your body (or your bank account) when it tells you that your current regimen is too intense.
But saving more is definitely a good idea. Many pension experts are now saying that the traditional recommendation to save 15% of income is, frankly, too low. to guarantee a comfortable retirement, and that 25% or 30% is a safer rate.
Also, keep in mind that if your goal is to retire early or someday leave a well paying but stressful job, your savings rate should probably be 50% or more. It may seem impossible, but it can make you think twice when making important financial decisions, such as deciding how much to spend on a house or car.
The most important thing is to start saving. How much will vary from person to person, as well as from year to year. The best savings philosophy, in line with our sports metaphors, comes from Nike: “Just do it.”