I’ve asked myself this question a lot lately. How much of our income should we be saving given that over the last few years, our income, life situation and priorities have changed significantly.
Our savings rate has always been determined according to the ‘as much as possible’ principle. For the 2017 financial year that turned out to be over $30K. Not bad since I was on unpaid maternity leave for a fair chunk of it.
But I keep wondering, is it enough to meet our goals? Or perhaps is it too much?
Is there a straight forward answer to ensuring we are saving the right amount? I went in search of an answer and found that it’s about as clear as anything related to saving. Clear as mud that is.
How do you savings compare to the average?
A recent survey by Suncorp has found that the average Australian is putting away about $427 per month. The Sydney Morning Herald suggests it’s under our mattresses’ and they’re probably not that far off given that 65% of Millennials are keeping their money in cash rather than investing it.
Well, that’s one survey. Figuring out who is doing what with their savings – a topic that you would think would be pretty cut and dry – seems to be an impossible task. For example:
- 47% of Americans in one survey would need to borrow money to pay for a $400 emergency;
- According to public relations company Edelman, 63% of Millennials aren’t saving for the long term;
- But Facebook says, while only 37% of Millennials have a financial plan, 86% save;
- While youngings in Australia are saving above the national average of 12% of disposable income at a rate of $533 a month.
So if that leaves you with no idea of what anybody else is doing, that’s fine. Let’s forget about average for a minute and focus on the savings rules.
The 10% Savings Rule
I’ve always heard that at a minimum you should be saving 10% of your income for your retirement. Which means in Australia, if you’re employed, the super guarantee should do most of the work for you, with 9.5% of your earnings being paid on your behalf by your employer.
The only problem is, 10% isn’t likely to be enough for a comfortable retirement. It also requires consistency over your working life which for most people isn’t likely to happen.
Think parental leave, sick leave, becoming a contractor, part time employment, extended periods of travel and of course unemployment.
Plus the 10% rule assumes that you’re working up to the preservation age AKA 60 years at this point in time.
Oh and don’t forget that you still need to save for an emergency fund outside of your retirement savings.
So 10% at best is a minimum percent of your income you should be saving.
The 50 / 30 / 20 Rule
The 50-20-30 Rule divides your spending into three categories:
- 50% of your income goes essentials like housing, food, insurance etc.
- 20% of your income goes to financial goals like savings, investments and paying down debt (not including a mortgage).
- 30% of your income is used for flexible spending, that is, the stuff you don’t necessarily need like dinner out or travel.
So in the case of the 50 / 30 / 20 Rule, at least 20% of your income is being saved, unless you have credit card debt or car repayments etc to pay down first.
In actual fact, your savings rate may be higher depending on whether you include retirement savings withheld by your employer or not. From what I can tell, the 50 / 30 / 20 split is usually based on your after tax / super contributions are taken out. Let me know if you’ve seen it done differently.
The main reason this rule is so popular, is that it provides a really nice, easy way to split up your income and a gives a clear savings rate to aim for.
Is a 20% savings rate (on top of retirement savings) enough? Depends. What are your financial goals? I’d say that if you like your job and are happy to keep working it probably gives a nice amount of slack.
In other situations, maybe not.
Are you saving for a house deposit and you want to get into the market sooner rather than later?
Do you have a lot of debt that you want to knock on the head?
Do you want to retire early?
Enough for Early Retirement
Take a stroll through the early retirement branch of the interwebs and you might see people racing towards early retirement with saving rates of 50, 60 and even 70% of their incomes.
Those are some serious savings rates that are pretty hard to achieve. But are they enough to achieve early retirement?
If you seriously want to retire early, there are two numbers you need to know. How much you’ll need and when you want to retire.
The rule of thumb for calculating your retirement number is to multiply your annual expenditure by 25. This figure needs to be invested in income generating assets such as stocks, bonds, and real estate to retire safely. So if you’re spending $50,000 a year, you need $1.25 million in investments.
The second question is; when?
To accumulate $1.25 million in 10 years at a rate of return of 7%, you would need to be saving $85,000 a year. Or the equivalent to the annual capital gains of an average Sydney house! Ha ha.
You may have heard that time is of the essence in saving and investing. In this instance, if you wait an additional 5 years to retire, you’ll only need to save $45,000 per year over that same period. Significantly more achievable, right?
The law of diminishing returns also applies, because at some point saving an extra $5,000 per year doesn’t yield all that much extra capital, but it can be very difficult to shave that amount from your budget.
If early retirement is your goal, then the answer to how much you should be saving is: as much as possible.
To hit on an exact figure, that takes into consideration what’s possible, play around with a simple savings calculator.
At the end of the day, there’s no blanket prescription for everyone. Anything beyond 10% is a good starting point, but the best answer to ‘how much of your income should you be saving’ is; enough to achieve your goals in life.
The best way to ensure that you’ll do that? Make it a habit to save today.
Agree? Disagree? What’s your definition of a good savings rate?
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