People often give unsolicited advice. When it comes to the percentage of my income I should save, the range is immense. Different advisors, whether it’s a professional, family member, or friend, have recommended different numbers.
To play it safe, I’ve stuck to the rule I often hear, which is to save 10% of your income. But now that I’m getting into my 30s, I’m questioning whether it’s enough. Should the amount increase year by year? I’m starting to save more, but that’s because I’m also making more. Technically, it’s still 10% of my income.
My concern stems from also hearing that some people have been able to save 70% of their income with a better chance at retirement. While I don’t believe that’s possible for me, I’m concerned that 10% of my income is far from what I need to retire comfortably. Were they able to save such a high percentage because they invested heavily and aggressively? If this is likely the case, should I consider doing the same?
– Confused but Committed
Dear Confused but Committed,
Unsolicited advice is hard to deal with and even worse, can be conflicting advice! One of the biggest myths in the personal finance world is that there is a certain percentage of income that everyone should be saving. What you should do with your money really depends on YOU – where you are today and what your goals are.
Save as much as you reasonably can
My favourite rule of thumb for the ideal savings rate comes from Carl Richards, Certified Financial Planner and author of The One-Page Financial Plan: “Save as much as you reasonably can.” Now I know that this might be an infuriating answer, but hear me out. Setting a savings goal based on what’s reasonable does two things:
- It requires that you take an active role in your financial life. You’ll only know what’s reasonable if you understand your committed expenses and what your goals are.
- It gives you the flexibility to take advantage of higher earning years, and gives you breathing room when cash flow is tight. What matters most is that you maintain the habit of saving, no matter how much or how little you can manage.
Savings Rates vs Savings Goals
That being said, it sounds to me like what you’re really after is peace of mind knowing that your retirement goals are achievable. Instead of worrying about your savings rate, I think what you really need to focus on is your savings goal. How much money do you need to have in the bank to retire comfortably? Unless you know what that number is, no rule of thumb on how much you should be saving can provide you with any real comfort or clarity.
Figuring out your retirement saving goals might be simpler than you think. Begin by estimating about how much annual income you’d like to have in retirement. Try thinking about it in the context of your current income. When you’re retired, would you like to have more, or could you live with less?
Once you have that income goal in mind, the rest is just math. There’s a formula that calculates the lump sum of saving you will need at age X to produce that income over your retirement years – it’s called the present value calculation. There’s also another one that calculates how much you need to save on average each year between now and retirement to get to that goal – this one goes by the payment calculation. Divide your required annual savings by your annual income today and THAT’S your unique required saving rate.
If you find these formulas to be intimidating, a financial professional (see why I recommend fee-only planners) can guide you through how to apply them to your specific situation.
What if I want to retire sooner?
For most people, saving between 10-20% of their income puts them within the range of retiring after 30-40 years of saving. But what if you’re one of those “financially independent and retiring early” seekers? That savings rate just isn’t going to cut it.
How someone achieves a savings rate of 70% is more about living below their means than it is about investing heavily and aggressively. Investment decisions are mostly based on risk and reward, not solely in the dollars available to invest. You should only invest in this way if you have both the appetite for risk and the ability to take it on (that is, a long time horizon).
Ultimately, my (solicited) advice for you is this: make an appointment with a financial professional to calculate your retirement savings goals. Map out a savings plan that demonstrates how much – in dollars – you need to save each year, and the required return on investment you need to achieve that goal. If your goal is to retire early, then that savings rate might in fact be upwards of 50% but at least you’ll know with certainty, and will have a savings plan you can truly commit to!