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- My financial planner clients always want to know: How much do I really need to save each year?
- It all depends on your goals: think about how and when you want to retire, for example.
- The more expensive your goals are and the faster you want to reach them, the higher your savings rate should be.
As a financial planner, I help many different types of people with their finances, and they all tend to have one major question in common: How much should I save each year?
Regardless of income, goals, relationship, or family situation, everyone wants to know the “right” amount to save now so they’ll have enough in the future. And that makes sense, cause we all need to save Something.
So if you’re wondering how much you should save each year, try using this framework to focus on an optimal response to your situation.
What to Consider When Setting an Annual Savings Goal
You need to know your goals before you know how much you need to save. When we consider a general amount to save each year, we usually consider long-term goals like retirement or financial freedom.
The more aggressive your main financial goals – the more expensive they are, the faster you want to achieve them, the more individual goals you have – the more you need to save each year to fund them.
For example, the savings rate required for someone who wants to retire at age 65 and pay for some, but not all, of their child’s college education need not be as high as someone one who wants to retire at 50, buy a vacation home, send their kids to private college and pay all the fees, and travel a lot once they stop working.
Obviously there is a plot space between these two extremes. Consider where you might be on the spectrum to get an idea of how much (or how little) to save.
In this example above, the first person with modest goals may be perfectly able to save 15% of their income each year. The second person, however, may need to save up to 40% of their income to build up the assets to fund whatever they want.
You also want to choose a savings rate that, when combined with a reasonable and probable rate of return on that money, produces a consistent rate of success later in life. Put simply, this means we want to save enough so that we don’t have to rely on unrealistic expectations of investment returns.
The more you save, the less you earn have earn on your money to make your plan work. This is important because it means you don’t have to take as many risks to achieve the same goals.
But you also want to choose a savings rate that’s realistic and sustainable, that you can commit to, and that you can stick to over time — because you’re going to have to save and dungeon save to achieve success.
Finally, you want to consider what other sources of money you will have in the future once you stop working. For instance:
- If you have a reliable inheritance that you expect to receive in your lifetime, you may not need to save as much (but don’t totally rely on it to make your entire financial plan work – there are no guarantees!).
- If you have a lower income, you may receive more Social Security. Social Security replaces more of your income when you are in lower income brackets. The more you earn, the more income you will have to replace yourself in retirement.
- If you have a pension, you may be able to save a little less and still achieve your goals.
Potential savings rates to consider
To help you focus on a specific range, consider the following:
If you save less than 10% of your income: Save more if possible! If you’re building wealth from scratch and have a list of goals longer than “retire in my 70s”, a less than 10% savings rate year over year n is not enough to get you there.
There are exceptions to this. For example, you may be trying to develop your assets in a different way. Maybe you’re starting a business and need to reinvest all the profits back into that business to grow, or you’ve just had a really tough year and you just need to focus on breaking even.
But in general, most of us need to save at least 10% (but probably much more) of our income each year in order to reach the financial goals we have set for ourselves.
If you save 10 to 15% of your income: This is the baseline that many experts recommend for a savings rate. This is a good starting point if you plan to follow the typical path and retire between ages 65 and 67 (or even later). It’s also a great place if you earn less than six figures.
However, this may not offer you much flexibility during your retirement years, and you will most likely have to rely on additional sources of income like Social Security to have enough to last your lifetime.
If you’re earning six figures, you should probably aim to save a higher percentage of your income to make your long-term goals more achievable.
If you save 15-20% of your income: Saving at this level is probably where you start to see some flexibility in your future. This savings rate puts you on the right path to achieving financial stability and enjoying a few more choices in the future (like retiring a few years earlier or being able to move into a lower-paying but more satisfying job. in the future).
If you save 20-25% of your income: You are in line with the baseline that my company recommends for our own financial planning clients. We find that, for households earning $250,000 or more, saving 25% of income is entirely achievable and still leaves plenty of cash in hand to use to enjoy life in the moment.
The reason we love the 25% benchmark is because that’s usually where we start to see all kinds of different financial plans that consistently show high odds of success. We like to err on the side of saving more rather than less to ensure that clients will have plenty of wealth later in life to enable financial freedom and choice rather than being restricted in any way.
If you can maintain this level of savings for many years, not only are you building a good level of assets for the future, but you are also giving yourself the flexibility to reduce this savings rate at some point in the future. , as the power of time in the market and compounding returns are starting to let your money do the work for you.
If you save 25% or more of your income: This is a great place if you are serious about early retirement or financial freedom. The sooner you want to achieve financial independence, the higher your savings rate should be. It’s very likely that 40-50% – or more – is needed to reach your goal if you’re aiming for financial freedom in your 40s or 50s.
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Stick to a savings rate (not a dollar amount)
No matter where you decide your answer for “how much to save”, be sure to set your goal as a percentage of your income. Do not use dollar amounts.
By using a percentage (like 10%, or 25%, or 40% of your annual income), you keep your savings relative to your income. This means you don’t necessarily need to change your savings goal every time your income fluctuates.
If you commit to consistently saving 20% of your income, you can avoid lifestyle inflation even when you get a raise; the dollar amount you save will naturally increase, as your savings goal will be 20% of your higher income.
On the other hand, if your income drops, the amount you need to save will also drop (which is reasonable when you’re not making as much money and have less cash available for all the things you need to afford) .
Keep in mind that good financial planning is dynamic and changes over time. It’s worth periodically reviewing your savings rate to determine if your target percentage is helping you stay on track to reach your goals or if you need to make an adjustment.
We see this most often with clients whose income is increasing year over year; if that sounds like you, you might also consider increasing your target savings rate to take advantage of this potential financial power. The more you earn, the easier it is to save a large portion of your earnings.
Saving is good, but don’t stop there!
We tend to default to the word “savings” when we have these conversations, but we need to be clear that “saving for the future” really means taking the money you’ve set aside from your income and invest this.
Saving money is a great idea for short-term goals that you need to fund over the next few months up to five years. After this point, however, it’s worth considering whether you should invest that money instead.
Leaving cash aside exposes your money to a loss of purchasing power, especially if inflation continues to rage.
Investing, however, gives you the opportunity to earn returns. Keeping your money invested means that those returns can generate their own returns, and that’s how compounding can start to work in your favor to build wealth.
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