People like rules of thumb and quick answers. When a complicated question can be answered by an authority with a simple response, the reaction is likely to be one of two possibilities: a feeling of well-being and satisfaction if the questioner is meeting the requirements, or motivation to improve if the ideal situation is not being met. So if that’s all you need, the answer to that question I’m posing today, a number that represents the ideal savings rate as a percentage of income, let’s go with an answer of ten.
If you can save ten percent of your income throughout your life, you’ll probably be fine; in fact, you’ll be in a better financial position that most of your peers.
Most people don’t need to delve any further. If a reader is saving less than ten percent of her income, this bit of information may be all she needs to get the inspiration to save more, though additional motivation might be necessary to achieve a ten percent savings rate. If a reader is saving more than ten percent of his income, he might feel satisfied with the status quo, and not see the need to improve his situation. In that case, a rule of thumb could actually be preventing a reader from realizing his potential.
Very few things in life are strict prescriptions, black-and-white. This is why I’m not a fan of generalized advice. The self-help industry uses generalized advice as its foundation. Yes, there’s a possibility to motivate, but there’s also a potential for serious harm. A nutritionist who becomes familiar with your lifestyle and your needs can offer you better dietary advice than a popular diet book. A good business coach can understand your family’s needs and your skills and tailor advice to your situation. A financial adviser can study your financial situation, your goals, and your potential, and tailor an investment plan to you that makes sense. These types of advice can’t be sold to a mass audience.
In order to really figure out what your best savings rate might be, and if you want a better answer than “as much as possible,” you have to think about a number of other questions first.
What does it mean to save money?
The concept of saving money has had a good run since the Great Recession. Large-scale economic problems have affected people on an individual level, and as a result, the idea of frugality experienced a surge. The trend seems to have died down as the economy improved, but some people who got into the habit of making better choices about spending money have maintained those habits.
But being smart about using coupons and looking for deals isn’t really saving money. To have an impact on your finances, you have to do more than just spend less. You have to take that differential and put it away. You’re not saving money if you take advantage of a sale and then use your surplus for another spending purpose. That money must be put aside for the future, whether in a bank account, a long-term investment, or your mattress. That, and only that, is saving money.
What am I saving money for?
There’s more to life than having a big bank balance. Money is meant to be used for some real purpose. I feel somewhat sorry when I hear about someone who recently died intestate possessing millions of dollars that no one knew about, even family. Perhaps the money offered these people some peace of mind while they were alive, but aside from that, there are so many other possibilities, so many missed opportunities. You don’t need to be wealthy to be happy, but if you’re going to amass significant savings, it’s better than you direct how it will be used than leave it up to the state (who will have to go through the trouble of finding an heir).
It’s good to create a guiding principle for living your life, a personal mission statement. That can help you determine exactly why it’s important for you to save money faithfully. Perhaps there is a charitable cause about which you feel strongly, that could use your assistance. Perhaps you just want to have the freedom to never need to work to make a living. Perhaps you want your children and grandchildren to not need to worry as much about financial problems. Maybe you just want to travel.
Whatever you goals are, you should make it clear to yourself exactly why savings is important. Being able to retire should be the lowest bar. What will you do when you’re retired? How do you want to spend your time when you don’t want or can no longer be able to work?
Who am I saving money for?
Your savings needs depend on who is depending on you. Do you plan to support a spouse? Do you want to pay for your children’s education? How many children do you want to cover, and how much money are you willing to commit to their expenses? Private high school or public? Expensive university or community college? Are you saving money for starving children living in poverty in the world (or just to visit poverty)?
What is my number?
I’ve read a lot of books about personal finance, and The Number by Lee Eisenberg is one of my favorites. That says a lot considering I don’t like most personal finance books at all. Once you know why you’re saving money and who needs that money, you’ll be in a better position to determine your target, and this book can help you hone in on what that number might be.
Your target can change over time, and I like to remind people that a bank account balance is not a real goal, but having a number in mind will help you determine your ideal savings rate.
How much have I already saved?
To determine your needs, you have to know where you stand today. I know I couldn’t get started on my path to improve my financial situation without taking an inventory. Even before you get to listing your assets and liabilities on a sheet of paper or on the computer, you need to do a little self-evaluation. What is your relationship to money today? Does money make you anxious? Are you worried about being poor? First, determine what kind of emotional effect money and your financial situation have on you (and your family, if applicable). Then look at the logical side — the numbers.
You want to be able to end each month knowing exactly how much money you have (or owe) and how that value is changing on a month-to-month basis. You can see examples illustrating exactly how Consumerism Commentary readers go through this process of accounting for and analyzing their net worth, income, and expenses each month through the Naked With Cash series.
The amount of money you’ve already saved towards your goals can affect your future needs to save. How that money is stored — whether in long-term growth investments, interest-bearing savings accounts, or your mattress — also factors into the calculation. For example, if you’ve already exceeded your long-term savings goal, you don’t have to concern yourself as much with a future savings rate — you just want to maintain.
How much income do I have?
Given the same goals and the same final number, as well the same initial savings balance, a household earning $100,000 a year will need a lower savings rate than a household earning $80,000 to reach those same goals. If you’ve noticed, many of the early retirement gurus have saved money during periods of time while they were earning more money than the average American worker. Saving money is just easier when you have more income to work with. Yes, there is always a possibility of increasing saving rate by reducing expenses and spending less, but there’s a finite limit to that. You need to spend money to meet your basic survival needs.
The income side is relatively unlimited. And an increase in your income can be your biggest friend as you save towards your financial goals.
What will my future income and expenses be?
If you are on the path for a career of high earnings, or you have a good probability of receiving an inheritance, this could bode well for your ability to save enough money to meet your goals. Beware of lifestyle creep; as your income does grow, your expectations tend to change, as well. As a twenty-year-old beginning your career, you may have no idea what kind of lifestyle you want to live in the future, nor will you know how much that lifestyle will cost. As you gain more experience as an adult, you learn new things. You may start a family, and now you’re thinking about more than just yourself when you consider your future needs.
It’s extremely difficult to predict what your income and expenses will be in the future. People who predict their needs with confidence are often wrong. Nevertheless, making some educated guesses about the future, based on your chosen career path and your other life choices, is better than moving forward blindly (or not moving forward at all).
What will the world be like in the future?
Just like it’s difficult to predict your future situation, it’s even more difficult to have a good understanding of what the world might be like thirty or forty years from now. We make financial decisions based on the environment today, whether those choices involve good places to raise a family or investing accounts that have tax-related consequences. We never know when, for example, Congress might change the law so that Roth IRA withdrawals are subject to a tax, but we invest in Roth IRAs today with the assumption that withdrawals will be tax-free.
Seemingly even more extreme, we don’t know what form of government might exist in this country several decades for now. There’s a good chance it will look like today’s system, but you just don’t know. Ocean levels could rise and climates can change, prompting significant population migration. These changes as well as some we wouldn’t even be able to conceive today could have a significant affect on your ability to reach your financial goals in the future.
But the best we can do is make assumptions based on what we do know today while taking precautions to protect against things we don’t know.
So you might take all of this into consideration and determine that as a non-profit worker who doesn’t plan to go into management, you need to save 50% of your income in order to reach your goal of retiring on time. Or you might look at your job as a bond traders and figure you need to put away 1% of your income in order to retire to Fiji by the time you’re thirty-eight years old.
Your situation might reflect the “average American,” and chances are good that you’re close enough. But there’s also a good possibility that you are living in a situation that makes average advice irrelevant. Either way, take some time to think about these questions when you decide to take your future seriously. But don’t wait for the perfect answer — start saving ten percent today while you think about what you really need.
Published or updated July 2, 2014.