How much of your income should you save?
Your ideal savings rate depends on your goals and when you want to reach them. Are you saving for retirement? A vacation? Creating an emergency fund? There are also a variety of circumstances that can affect how much you should save. We’re going to breakdown the savings timelines and factors that go into figuring out how much to save and when.
How long will it take you to save?
Having a goal in mind when starting to save will help with motivation. It’s vital that you set reasonable timelines in which you can expect to reach your goals. This will help you not get discouraged along the way.
One Year or Less
These short-term goals tend to be a bit easier to define as they tend to be a bit more tangible. Holiday gifts and vacations fit in this timeframe. Short-term goals tend to be easier to plan for because you know with some certainty how much you need. There will always be some unexpected expenses with a vacation, for example, but you at least have a rough idea of the larger expenses for the trip.
Less Than One Decade
This is in preparation for a major expense, things like a down-payment on a home, paying cash for a new car, or a wedding. These are things that can take a while to save for.
This is your retirement and emergency fund. An emergency fund is to help you survive between jobs. When building your emergency fund you want it to be between 3 and 9 months worth of your income. This is to help keep you afloat should you suddenly find yourself unemployed. This pool of money will also cover you should you have large, unexpected expenses, like if your hot water heater goes out or you need to cover a large insurance deductible.
For your retirement, you should be saving about 5-10% of your income. If saving an additional 10% on top of what you’ve already been saving sounds like a lot, don’t worry. If your employer matches, that will factor into this percentage. So, if you save 5% and your employer matches another 5%, you've accomplished a 10% savings rate.
What are your monthly expenses?
Before you start saving money, you want to take an inventory of your expenses. The easiest way is to divide these items into categories like essentials and luxury, for example. Your essentials would be expenses like rent, insurance, a car payment, and groceries. Items like clothes shopping, dinners at restaurants, and morning trips to the coffee shop are luxury expenses. When deciding how much to save, you want to make sure you’re covering your essentials. From there, you can determine what you can cut from the luxury category. Small changes like making your own coffee and limiting your trips to the mall have the potential to free up a lot of money. For more information on auditing your expenses, check out our blog post, Determining Wants vs. Needs to Reach Financial Independence.
You also want to make sure that you aren’t saving so aggressively that you end up struggling to make ends meet. However, the sooner you start to save, the better. Some will say that a millennial doesn’t need to worry about retirement as much as a baby boomer. While this is true because a baby boomer is closer to retirement age than a millennial, this assumes that everyone wants to retire at the average retirement age. The sooner you start saving for your future the better off you will be in the end. If you start saving when you are young, the more money you will accumulate by the time you reach retirement.
If you are looking for a simple answer, the general rule of thumb is to save 20% of your income. Now if that seems like too much, it’s ok. Just remember that saving something is better than saving nothing. Start with what you can afford and work your way up to 20% when and if you can.