How much should I save?

The national personal household savings rate has recently increased from 7.6% to 8.1%. Still, it’s a far cry from the all-time high of 20.6% in 1973.

We often hear 10% floated around as a savings goal to target. But Jacob Lund Fisker, of Early Retirement Extreme, has a unique perspective on savings.

If you save 10% of your income each year, meaning you spend 90%. At the end of 9 years, you will have amassed the equivalent of 1 whole years’ expenditure.

Effectively, you can buy your own long service leave through this plan.  Imagine a year off work, all expenses paid, every 9 years!

Let’s take it to the next step though.

Needs vs wants

How much of that 90% you’re spending is ‘needs’ versus ‘wants’? While needs and wants are relative and everyone’s perspectives will differ, perhaps only 50% of your total income goes to truly basic needs. (Rent/mortgage, fresh fruit/veg/meat, basic toiletries, utilities).

Another 40% might be directed to wants. (Fancier food dining out, seeing movies at the cinema rather than at home, bottles of soft drink rather than water, takeaway coffee at work rather than making your own from the free instant coffee in the kitchenette, power wastage running the aircon unnecessarily, the fancier shampoo that does the same job as the cheaper brand but smells nicer and has a more attractive bottle…!). And then, you have the 10% set aside for savings.

If you can redirect that 40% to savings instead, all of a sudden, you’re saving half of your income – and for every year you work, you’re buying yourself a year off.

One for now, one for later

Imagine if, every day you went to work, you could say to yourself ‘by working today, I’m not just providing for my needs today. I’m buying myself a whole other day off in the future’!

If you have a large enough income, few enough debts, and are prepared to be really extreme, you could even flip the traditional advice on its head. You could save 90% of your income whilst living off of 10%. Then, every year’s work would buy you 9 years not working.

Of course, not everyone can save 90% – or even 50% of their incomes. Income inequality is enormous. While a tiny proportion of people have enormous incomes, and some people have decent or high incomes, the vast majority do not.

Even if you are only able to save 5% (meaning every 18 years’ work buys you a year off), or less, it is immensely worthwhile. Not only will these funds provide you with a safety net in times of need, but you can get your money to start working for you.

The ‘magic’ of investing

The best thing about the above models is their simplicity. As they don’t take into account investment returns, the real scenario is likely to be much more favourable to you. That is, once you invest your money and have it earning more money for you (provided inflation is not higher than your return) you’ll be making money when you sleep.

For example, at 4% interest, Fisker notes that 10 years’ worth of savings will likely last something more like 12.38 years. If you save up 20x your annual salary, this interest rate will produce 37.39 years. That’s a massive increase over the initial gain.

Free in five

Investing 75% of your income, Fisker notes, should allow you to achieve Financial Independence in around 5 years.

How to figure out how long it will take for you to achieve your own independence is covered in Fisker’s excellent book, Early Retirement Extreme. But for a quick calculation, Rob Evolves has a fantastic spreadsheet that shows you on a monthly basis how much you need invested, how many more years until you are financially independent, how many months’ expenses you have saved, and how many months’ you have saved with interest.

No matter what your current savings rate, a positive savings rate is better than a neutral or – gasp! – negative one, like Australia had in 2002, when the average household was spending more than it earned.

Think financial independence is right for you?

If you are currently debt-free: save something today, no matter how small. Jump onto a site like ratecity.com.au or search for ‘savings account interest rate comparisons’ in your country. Open up the highest-interest savings account you can if you haven’t got one already. Then check out Rob Evolves’ spreadsheet and start counting down the days to your freedom!

If you have debt: pay something toward your debt today, no matter how small. Start with the debt that has the highest interest rate and begin reducing the amount of interest you owe today. Then jump on to a debt calculator and see how much time you’ve just shaved off your loan! (RateCity also has an array of calculators for you to play with)

Also check out: firecalc.com All you need to know is how much you spend per year, how big you plan for your portfolio to be (you can try different sizes and play around with this figure) and how long you will need it to last (your expected age at death minus age at retirement, perhaps with a buffer). This calculator will show you, based on past periods of investment, how likely your portfolio (if invested in the US stock market) would have been to last that length of time over a number of cycles. It’s just a simulator and may not be all that applicable to us, but is interesting to try anyway.

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5 thoughts on “How much should I save?

  1. Haha “perhaps with a buffer” …indeed.
    It’s always a little hard to know what to estimate for expected age at death.
    It would be an interesting longitudinal study to see if people that achieve financial independence live longer due to lack of work stress 🙂
    Thank you for the thought provoking post.

    1. Hehe, yes indeed Anna!
      Hopefully we all lead long, healthy lives…!
      You raise an interesting question regarding the relationship between financial independence (vs. work stress) and longevity. In fact, I was inspired by your comment, and a conversation I had with another friend, to write a post about this very topic: https://www.enrichmentality.com/what-is-the-connection-between-health-and-wealth/ – there are some surprising findings.
      Thanks for your comment ?

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