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How Much Money Should You Save? Print
Thursday, 7th May 2009 (by J.D.)This article is about Basics, Choices, Retirement
At CNNMoney, Walter Updegrave hosts an “Ask the Expert” column in which he fields reader questions. (Updegrave is an editor at Money Magazine.) Lionel from San Diego recently wrote in with a question that all of us have:
What percentage of income should someone save in order to be considered financially responsible? I’m wary of spending now because of the bad economy, but I don’t know how much I should be saving on a monthly basis.
This is a great question, and something I’ve wrestled with over the past year or two. Ultimately, I decided to embrace Elizabeth Warren’s balanced money formula, which says to set aside at least 20% of after-tax income for Savings, keep Needs below 50%, and use the rest for Wants:
In other words, my target savings rate is 20% of my income. My wife tries to save 25% of her income. We’ve structured our lives to make this possible. But what does money expert Walter Updegrave recommend? First he notes that Americans aren’t exactly savers:
When it comes to socking away bucks for retirement, the National Foundation for Credit Counseling’s 2009 financial literacy survey also shows we’re not exactly knocking ourselves out. About a third of those polled said they put away nada for retirement, another third save 1% to 10% and just under a quarter save more than 10%. (The rest said they didn’t know how much they set aside or refused to answer.)
But then Updegrave gives a great answer, which boils down to: Do what works for you. There is no right answer to this question. Each of us is in a different situation, and while it might be financially responsible for me to save 20% of my income, for you that number might only be 5%.
Updegrave says that it’s not important what percentage of your income you save, but that you develop the habit. Build an emergency fund. Develop a retirement savings regimen. When you’ve done these two things, look for a additional ways to save. Most of all, he says, don’t make excuses. We all have things we’d rather spend our money on; if your goal is to be financially responsible, make saving a priority.
Note: Flexo at Consumerism Commentary recently wrote about Updegrave’s advice as well.
[CNNMoney: 3 steps to financial security: Save, save, save]
May 7th, 2009 at 11:12 am
I’ve also found Warren’s formula helpful. Especially since she comes to it after studying bankruptcy. She put a lot of thought into it. For example, disability payments would likely cover all your “needs”. Of course, you’re always welcome to save more, but I like this formula because it gives me confidence that I’m doing “enough”, and actually makes me spend more on “wants” than I would allow myself otherwise. (And some of those “wants”, like my new mandolin, bring a lot of joy to my life). Oh, and I apply these ratios to my income after tax and after charitable contributions. Her book is an enjoyable, quick read. I also really like The Two Income Trap, by the same author.
May 7th, 2009 at 11:21 am
Instead of a percentage based system of how much should be saved, I use a lump sum amount which equals 3-6 months of living expenses (comprised of wants and needs) I have summed up in my budgeting spreadsheet.
Again, with savings, you have to come to a point where you ask yourself, how much is enough. I tend to save more than the typical 3-6 months of living expenses and feel I should invest the rest but I like having the liquidity at any given moment.
Great article
Thanks.
May 7th, 2009 at 11:22 am
Nice post JD, when I started building my emergency funds this was the question on my mind for quit some time. I agree that the best thing one can do is to save as much as possible. I am 23, single and (fortunately) managed to be away from any kind of indulgence; said that I ca manage to save more than 50% of my post-tax salary
May 7th, 2009 at 11:44 am
I’m still in debt repayment, so I don’t fit the chart exactly. My balance works out to this:
38% Household
37% Repayment
20% Personal
5% Savings
But my plan is to shift the majority of the Repayment money over to savings once we are fully paid off.
I should comment that I find the Wants/Needs/Savings breakdown a little difficult to apply to my finances. Do I consider a cell phone bill a Want or a Need? I consider it a utility in general, but I fully recognize that I could choose to lose the service if I needed to reduce spending. Likewise, in my personal category, I include certain obligations, such as gas for my car, that are pretty essential towards remaining employed.
ETA I didn’t include my pretax contributions to my 401K in my savings percentage, as I calculated the numbers using my take home pay. I put 6% pre tax into that account.
May 7th, 2009 at 11:54 am
Does that 20% include all savings? (i.e. Emergency Fund, Roth, 401k, etc…)
May 7th, 2009 at 11:54 am
What if you’re not saving for retirement? What if you’re saving for (for instance) a new car? Say the car you want costs $20k. Assume you could finance it at zero percent interest.
Say $500/month is 20% of your net income. You save this in your “new car” fund. Yay, you’re a responsible saver. 40 months later you spend it all on your new car.
Or, you borrow the money to get the car right away, now you’re an irresponsible borrower. There is certainly an advantage to having the cash on hand while you’re saving, as opposed to being liable for the car, but at the end of the 40 months, you’re in exactly the same position as the saver.
You could do the same with a mortgage payment. Throw $500/month into a “lump sum mortgage payoff fund” and you’re a responsible saver. When the balance of the fund exceeds the balance on the mortgage, you pay off the house.
Or, you can overpay your mortgage every moth by $500. It’s not viewed as irresponsible like the car loan, but still doesn’t generally count as “saving”.
The only advantage you get from saving in these situations (aside from interest payment issues, which I’m ignoring) is that the savings account, up until you you spend it on the house or car, can be hijacked as an emergency fund if you need it.
Because of this, I find it hard to separate “debt repayment” from “saving”. I think they’re actually the same thing. That may sound like I condone carrying debt. I don’t. I do think that if you *are* carrying debt, paying it off with 20% of your income every month is the same as saving 20% of your income every month.
May 7th, 2009 at 11:58 am
Nice post - I recently found out about this site and the blogs are awesome!
My partner and I have always been savers - we try to live off one income that would cover all expenses such as mortgage, bills, food etc and save all of the other income for things like retirement savings, emergency funds, and a car. But with the state of the economy these days, it just goes to show that you really can’t rely on company or government pensions to support you in your retirement - we hear of numerous companies filing for bankruptcies and not being able to sustain the current retirees pensions (ie. Chrysler or GM)…and with all the job losses, and people signing up for government assistance, there’s only a finite amount in that pot.
Now, more than ever, we look at it such that we try and save as much as we can on our own while pretending that there is no company or government pension when we retire. That way, the day we do retire, we will hopefully have saved enough on our own to sustain ourselves for the next 30+ years with our savings… and anything that we would get from company/government pensions would just be a nice bonus.
Our goal is to be self made millionaires by the time we retire
May 7th, 2009 at 12:02 pm
Another side of this debate is what do you truly consider savings?
Is savings something that goes into an account never to be touched again (or until retirement)?
Or is savings also something that goes into an account that can only be touched in case of dire emergency (loss of job, major unexpected expense)?
Or is savings also considered what you put in buffer accounts to handle month to month larger transactions that aren’t necessarily fixed (ie a wedding gift, minor auto maintenance, new printer, etc).
I like the idea of setting a certain % for savings vs wants and needs, but you have to be careful how you define savings.
May 7th, 2009 at 12:42 pm
This is retarded.
Gross Income = 100% Less:
25% Federal Income Tax
12.5% Social Security Tax
1.75% Medicare Tax
5.5% State Tax
5.0% Local Property Tax
1.0% Sales Tax (Est)
3.0% Hidden Taxes
10% Tithe to Church or To Charity
10% Retirement
SubTotal: 73.75%
Savings: 20%
Total: 97.75%
Exactly how am I supposed to feed my family on 2.25% of my remaining net income?
May 7th, 2009 at 12:57 pm
It seems to me people look at savings sometimes as a “come on, do I have to?” type deal.
Instead of spending 30% on wants, why not try not wanting so much?
I use close to 50% on fixed costs, after that I try to save as much as possible. If I want something, I purchase it but I just try not wanting stupid things.
Once you max your Emergency Funds, you can use the “savings” toward insurance, retirement, college, etc. All before looking into wants.
Then once you have all your ducks in a row, maybe you goal can be that “want” to retire early. If not, maybe consider giving instead of buying yo buy. Just a couple thoughts out loud.
May 7th, 2009 at 1:02 pm
If you truly want to build up assets to the point you can live off the income they produce without touching the principal, you will need to put much more than 20% of net away.
For years I’ve managed to stash 35% of gross and I still worry that I won’t achieve that goal by retirement.
May 7th, 2009 at 1:05 pm
Before I went back to school, I saved 66% of my after-tax income. I can’t wait to get back to earning (and saving) some real money again.
May 7th, 2009 at 1:06 pm
Pot. Kettle. Black.
May 7th, 2009 at 1:21 pm
i was thinking about how much i put in savings each paycheck - it varies because my budget is such that i have to focus on covering bills first, then save what’s left over - and at first i was a little sad to think it was rather low on average. but then i remembered that not only is my retirement contribution taken out of each paycheck before i see it, but i always include my automated savings withdrawals to various accounts in my “bills” calculations for every paycheck and i hadn’t considered those!
automation works!!!
May 7th, 2009 at 1:27 pm
@9 Huh
You may be in the 25% federal tax bracket but you are not taxed 25% on every dollar you earn.
Your effective tax rate will be much lower.
Divide what you owed by your gross and you will see you actually paid closer to 10-15% to the fed.
In addition, your property tax at 5% doesn’t apply to your total income either.
Add back another 6% in your pocket since half of your SS Tax is paid by your employer (self employed not withstanding).
Last, this article recommendation of 20% is inclusive of your retirement so you double counted that.
Needless to say, even saving 20% and giving 10% to charity you have a lot more than 2% to feed and house your family with.
May 7th, 2009 at 1:28 pm
My biggest question when I see statements like “Save 20% of your income” or “Pay yourself first (referring to putting money in savings)” is - what are these savings going towards? Am I supposed to be saving for retirement? Then just say that. Can I use some of those savings for a car but end up like the example in #6? Am I just supposed to be saving and living off the income from the savings?
And before I get the stock answers, yes I already put 15% toward retirement, I’m steadily putting money towards an emergency fund, and I have no other debt. So does saving for a house some day or a replacement car qualify under savings or under the wants/needs?
May 7th, 2009 at 1:40 pm
I’m with Nicki (#14) et al… please define “savings”!!!
May 7th, 2009 at 1:42 pm
For me
20% - 401k
25% - taxes
8% - ESPP
7% - IRA
15% - Saving for down payment on house
25% - Living right now
This is because we are DINKs
May 7th, 2009 at 1:48 pm
In addition to the comments about marginal tax rates, an important thing to remember is that if your saving is tax deductible, saving a given amount doesn’t reduce your spendable income by that amount.
May 7th, 2009 at 1:56 pm
How about don’t have a kid and then you will be able to save tons of $$$. Many people fail to see that.
May 7th, 2009 at 2:09 pm
@huh
http://www.getrichslowly.org/blog/2008/10/27/the-balanced-money-formula/
“The balanced money formula
The Balanced Money Formula is based on your net income (your income after taxes). ”
@Tyler Karaszewski
“…Saving comes last in this plan. Everything left after you take care of Wants and Needs is set aside for the future. (If you have consumer debt, that’s also tackled here.)”
Also,
“Needs are things you must pay no matter what: housing, food, utilities, transportation costs, insurance.”
A car would fit into “Needs” since it’s a transportation cost. Or, if you don’t have enough left in the “Needs” you could consider it a “Want”, especially if you are talking about a flash $20,000 car. Savings in my opinion in this strategy is left for 401k/roth/emergency fund (which, in my opinion, if you dip into, you pay back out of Wants/Needs later). Long story short, 20% should be there for retirement (or perhaps items like education), but definitely not a BMW.
May 7th, 2009 at 2:34 pm
NET Income:
Needs AND Wants (expenses)- 45%
Short-Term Savings (cash)- 33%
Long-Term Savings (investments)- 22%
Line between needs and wants gets fuzzy sometimes… so I just combine them as expenses. Short-Term savings are for a 20% down payment on a home and a new car, a wedding (eventually). I have an emergency fund I am comfortable with already. Unused money in my monthly budget is swept to my emergency account for irregular expenses. Long-Term is retirement, obviously. I am 25 years old, have a dog, and I have a girlfriend in college still that I don’t share any expenses with.
May 7th, 2009 at 2:39 pm
I agree that the numbers are useless unless you define “need”, “want”, and “saving”. JD has previously defined need vs want. A want for the most part has a large amount of discretion even if you need it (eg: clothes).
But “saving” has never been defined to my satisfaction. If I set $500 aside each month for a vacation that should come from wants as it isn’t saving. As was pointed out “car repair” is a need with non-fixed cost. If I set aside $100 per month for repairs am I only “saving” what I don’t spend?
I think of the balanced money formula (BMF) as more of a concept than a tool. The concept is that you should be able to live on about half of what you make (needs) but that it’s okay to spend money on yourself (wants), as long as you are taking care of future needs (saving).
I also agree with Tyler Karaszewski about debt repayment and saving being interdependent, but I would think there would be one BMF for debt repayment and one for non-mortgage debt free, because the risk of carrying debt is higher the wants should be less of a priority.
May 7th, 2009 at 2:50 pm
Hm. Interesting.
I didn’t re-capitulate the entire idea behind the Balanced Money Formula here because I don’t want to have to do that every time I mention it. Instead, I sketch the basics and trust that people will follow the link if they’re not sure what it means. I may have to reconsider that policy.
Anyhow, the Balanced Money Formula treats debt payments as Saving. I think this is clever, actually, and makes a lot of sense. They’re the same thing.
And what is Savings? That varies from person to person, I think. In my case, some of it goes toward retirement, and some of it goes toward other stuff — like a Mini Cooper.
May 7th, 2009 at 2:53 pm
Elizabeth Warren’s book says the 20% savings should be used to pay off outstanding debt (she also equates debt repayment as savings). After paying off debt and establishing a good emergency fund, she recommends at least 50% of your savings (10% of net income) go to retirement and use the rest for short term goals.
Of course, these numbers do vary depending on your situation, but it’s a great rule of thumb - very simple when most financial advice is frightfully complex.
We are just now balancing our finances. Our must-haves are high at this point, but in our early 20’s with two small children we realize it’s a temporary condition. Right now our wants are about 20% and savings is 5%. I am hoping to slowly come to a more balanced monely plan over the next five years. Eventually I want to be saving 15-20% of our net income.
May 7th, 2009 at 3:29 pm
I’m never really sure how to calculate how much I’m saving. 10% gets put away on the gross into a retirement account. This includes a match.
I also save 10% of my take home pay.
I really like the BMF. I can’t quite make it happen right now, but I want to work towards it.
May 7th, 2009 at 5:39 pm
“We’ve structured our lives to make this possible.”
This is a most profound statement.
No matter what the plan is - this concept is the core of any success we achieve. Recognizing the control we do have, making the plan, and making the changes required to support success are steps inside the core.
Thank you for this moment of reality.
May 7th, 2009 at 7:34 pm
@ Huh (#9) - What I consider my operating expenses (all expenses except mortgage) comes to
1%1.3% of my gross income, so it is possible to support a family on 2.25%.May 7th, 2009 at 9:05 pm
After I pay off my debt, I plan to set a “savings ceiling” and not to surpass it. Anything I accumulate over & above that ceiling will go to my church and/or the Lord’s work.
My goal is to free up my money, be a better steward of what God has entrusted me with, and give more liberally for the cause of Christ.
May 7th, 2009 at 9:10 pm
60-75% of my total comp consists of a bonus. I spend my base, and save my bonus. Hence, I save 60-70% of my earnings.
May 8th, 2009 at 4:15 am
I don’t agree with the idea that there is one saving percentage that is best for all anymore than I would agree with the idea that there is one model of car that is best for all or one sport that should be everyone’s favorite. Your saving percentage needs to be shaped to match your personal set of Life Goals.
I also don’t quite agree with the idea that the important thing is to get in the habit of saving (although I think that idea comes much closer to the mark). I believe that the important thing is to get in the habit of examining the trade-offs between spending and saving. if you do that, the saving percentage matter will take care of itself. Spending and saving are both good so long as the goal being pursued is to maximize the long-term value obtained from the money involved.
Rob
May 8th, 2009 at 7:20 am
Re: Rob at #31: The 50/20/30 numbers from Elizabeth Warren is based on her studies in personal bankruptcy. They will work for most people.
May 8th, 2009 at 7:27 am
For a more detailed review of All Your Worth with respect the balanced money formula have a look at:
http://www.mdmproofing.com/iym/BMF.shtml
May 8th, 2009 at 12:00 pm
@JD -
Sorry if you’ve answered this previously, but do you set aside a specific percentage of savings to short-term (ex: Mini fund) and long-term (retirement) or just allocate it on your own whims?
May 8th, 2009 at 12:20 pm
@Kevin M (#34)
My decision is somewhat whimmy, but not wholly so. I max out whatever retirement plans I have available, and then whatever is left over goes to short-term goals. The retirement options available to me vary from year-to-year, so I can’t say that every year I’m putting $5,000 in my Roth IRA or $8,000 in my 401(k) or whatever. I just put whatever I can in the options I have, and then anything leftover goes into savings.
And in reality, more goes into savings now. Saving has become my default. I save before I spend. That means that I usually have some left over at the end of the year (which is really April 15th, after taxes) to pull out and use for spending. That’s what happened to get me to my Mini Cooper faster than I thought was possible.
May 8th, 2009 at 1:01 pm
For your definition of “savings”, clearly you would count all of MY own contributions to taxable and retirement accounts. Would you also include the employer match? What about the reduction of principal in your mortgage (either the normal amortizing amount or any prepayments), as these are clearly monies that you could access later? Just curious as you really never see a good definition of what is included.
May 8th, 2009 at 1:59 pm
I’ve always been on the extreme end of conservative.
Save half. Always. No matter what. The secret: no matter what you earn, there are those living on half of that. Entire families probably live on half of what you make. Don’t forget it’s easier to maximize your earnings than to reduce spending (after a point), but still. It’s always possible.
You’ll know when to spend it. I was able to pay for a (used) car and a wedding without going into debt. Starting next month I’m going to live off savings as I start a new company.
Thinking about starting a blog called “Ramen Profitable” describing my obscenely frugal habits.
For example, I could probably reduce my spending to $400 a month.
May 8th, 2009 at 2:03 pm
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May 8th, 2009 at 3:32 pm
Why are so many people TERRIFIED and CONFUSED by the word “Savings”? It’s just a word folks. Here is how I look at things:
Run your home like a business.
1- Develop a budget that you can live with. This would include FIXED costs such as mortgage, tax, car payments, debt payments, utilities, anything ROUTINE. Budget must not exceed 80% of NET income.
2- INVEST (i.e. save) in yourself! Set aside 10-20% of net income in specified accounts. This can include IRA, 401k, CD’s, a separate checking account, whatever works for you. This “Investment” account should have 3 primary goals: 1) cover one-time expenses (like car repair, wedding gifts, etc), 2) accumulate 6 months BUDGET(emergency fund not to be touched), 3) dollar cost average into 401k or IRA. Once you meet the 6 month efund, THEN you can set aside money for wants.
But NOBODY wants to follow this plan because they have already allocated all of their net income to expensive HOMES or CARS they cannot afford and thus their operating budget leaves NO ROOM for investment (i.e. savings).
Unfortunately, society has adopted a “spend it now” motto, maybe that’s why so many people are CONFUSED by the word SAVINGS… they truly don’t know what it means because it’s not part of everyday vocabulary. How very sad. At least you have come to right place, GRS offers lots of resources on this topic.
May 9th, 2009 at 7:00 am
I think that those who think ahead and plan for spending are in the best kind of situation. They know what’s realistic to their day to day spending…what they can afford, and after that, saving is pretty easy. Beware of real estate agents who always will want you to buy a bigger house than you may originally want to. When my husband and I moved to our town, the company provided a special buyer’s agent to help us locate our new home. She knew important things to look for in the structures, etc…and pointed out many things that we would not have seen on our own. BUT, when it came time to decide on the house, she was very adamant that we buy the much more expensive house rather than the moderately priced one that we did eventually buy. We did the numbers before we ever met with her, and knew how long of a mortgage we wanted. She did all kinds of tricky math things to make it seem like we could bring the mortgage to what we could afford, but in the end, it all would have been out of our budget, and would have derailed our savings plans. I’m really glad we didn’t follow her sales pitches. That was a little over 10 years ago, and we will likely have the entire mortgage done in 2-3 years. We would never have been in this good a shape mortgage-wise if we had decided otherwise. STICK TO YOUR FINANCIAL GUNS WHEN BUYING A HOUSE!!!
May 11th, 2009 at 8:52 am
From #23: “I think of the balanced money formula (BMF) as more of a concept than a tool. The concept is that you should be able to live on about half of what you make (needs) but that it’s okay to spend money on yourself (wants), as long as you are taking care of future needs (saving).”
Wow. I’d love to find a way to live on $750.00 a month for 4 people, but I’m having a hard enough time doing it on the full 100%.
May 12th, 2009 at 11:36 am
I save 10% gross for retirement. This doesn’t include a match right now, but will include a 6% match in the future.
Last month I saved about 32% of my net income.
I’m doing this primarily to avoid as much debt as possible in the future as I’m saving up for graduate school a couple years down the road.
May 12th, 2009 at 1:41 pm
I track all of my month end account balances and total them up as a “net worth” number. I don’t count my house or car as assets in this number. I’ve found that over 2 years, I’ve averaged around $1000 increase in net worth per month. But the usual increase is higher. I just had some very large expenses like replacing my heat pump and refinancing my mortgage. Month to month, the net worth figure increases about $1600 each month. This includes my retirement funds, which I contribute $500 to (and my employer contributes $150 to) and it includes the account fluctuations due to the stock market (which also affected my 2 year average!)
Looking at that figure, about 20% of my gross income is going to increasing my net worth. It’s 33% of my net income, but net doesn’t include retirement deductions. But the other $350 or so is over 10% of my net income.
July 13th, 2009 at 3:50 pm
After reading this entry in May, I finally got around to picking up the book (All Your Worth) at the library. Not a bad book, overall.
I like having a different way to look at my money and budget (although I could never give up tracking all expenses).
After figuring out my expenses using this method (must haves, wants, and savings), I found some great news.
(1) We did a good job estimating our monthly must-haves for our emergency fund.
(2) Even if we have no extra income beyond salary (no bonuses, for example) we can easily meet our goals/wishes for all 3 categories.
(3) Our balance is a healthy 36% must haves, 23% wants, and 42% savings (which includes some pre-pay on the mortgage, but no other debt).
I’m feeling a lot more comfortable about spending for wants after running the numbers (something I’ve struggled with during this recession).
I’m also looking forward to comparing the planned numbers with actuals at the end of the year!