The median American household had only $11,700 in savings and 29% of households have $1,000 or less, according to a recent CNBC article. Whether it is retirement savings or savings for a specific long-term or short-term specific goal, there are many reasons why we should crank up our savings and boost our financial security.
This third article in the “10 Common Questions…” discusses the essentials of savings, including how much savings you should have, your savings rate and what you should actually be saving for.
Q: What classifies as savings?
Savings can include a variety of things. Some people refer to just their money in a savings account as their savings, but there are a few more savings to consider. Really “savings” refers to “any money you have set aside waiting to be used at a future time”. With this definition contributions to retirement funds as well as investments made can also be classified as savings.
Another way to describe savings are “any payments that improve your long-term finances”. This adds yet another option: paying off debt. After all, by paying off debt, you take away the interest charges as well as your dependency on your creditors.
In short, savings can be any or all of the following:
- savings account
- retirement fund
- debt payments
Q: How can I save if I never have any money left over at the end of the month!
A not uncommon situation that many people can find themselves in is that they have no money left at the end of the month, let alone any money to make those savings contributions.
But the solution to this problem is answered by the problem itself: “I never have any money left over at the end of the month.” If you wait until the end of the month to set aside money to save, other expenses become a priority. Whatever you allow to be paid closer to the beginning of the month, will naturally have a higher chance of being purchased as there is a higher likelihood that money is still available, whereas the closer towards the end of the month you leave a payment, the lower the probability that there is any money left over.
So in order to start saving you need to change your habits: put your savings allocations to the start of the month and make this one of the first payments you make. Then, with whatever is left, you need to make ends meet and not spend more than you have coming in. By switching the order around you ensure that you hit your savings targets AND stay within budget for the rest of the month.
Q: But currently interest rates are terrible!
At the time of writing, interest rates are indeed extremely low, often even below inflation. But there are several pro´s to keeping up your savings rate:
- An emergency fund means that you don’t need to borrow money and go into debt if you need money for an emergency.
- Cash is king, and having some funds available immediately when needed is a huge peace of mind.
- If you are looking for higher returns upon investments, instead of setting money aside into a savings account, consider investing the money or adding more to your retirment funds.
- Another way to use your money if you don’t want it to sit idly in a savings account is to pay off debt faster. In this way you avoid the accummulation of interest payments.
Q: How much should I save per month?
You should save how much you can and want to save each month, but a common answer to this question, at least to start with, is to save 20% of your net income. (This is based on the 50/20/30 rule that says to aim to spend 50% of your money on essentials (rent, food, utilities), 20% on savings goals and 30% on discretionary or fun expenses (holidays, nights out) ). Of course, these are only guidelines, and since your situation is unique you need to decide for yourself how much you can really save. But it’s a good starting point if you are not sure what a good amount would be. As your lifestyle is so different to other people’s, using a savings rate is much more helpful than using specific amounts.
Q: What’s so important about this savings rate?
Your savings rate tells you how much of you income you don’t need for your day to day life. The higher your saving rate, the less you live off. This is helpful in two ways:
- If you lost your job or were without an income for a while, it means you need to eat into your savings less simply because you’ll need less money to pay your bills.
- The more you save, the sooner you hit your savings goals.
Let’s look at an example. Say you earn $2,500 net a month and that you save 10% of this money $250 and therefore spend the remaining 90%: $2,250. That means it would take you 54 months to save up for a 6 months living fund ($2,250 x 6 / $250).
If instead of saving 10% you were able to set aside 20% each month, your monthly savings would be $500, your spending would be $2,000 and it would only take you $2,000 x 6 / $500 = 24 months to get together that 6 months living fund.
Q: What is my savings rate?
You can quickly calculate your savings rate by looking if you know your last month’s income and savings. If you keep a register of everything that you spend and save, this process is even easier, but even if you don’t and you need to work of approximations, that is fine too. To calculate your savings rate, find out how much money you allocated to savings expenses: this includes contributions to your savings accounts, retirement provisions, paying down debt and investments. Total these amounts, then divide this by your total net income.
If you set aside $50 in your savings account, $100 towards your retirement, $75 to pay down debt and invested $75, your total savings expenses were $300. If you take home $2000 each month that gives you a savings rate of 15%.
Q: What should I be saving for?
- Emergency fund – for any emergency expenses that are unexecpected and that you have to make in the moment, for example when your car or washing machine breaks
- 3 – 6 months living fund – to cover your expenses if you suddenly find yourself without an income
- Specific targets (vacation, new car, children’s education) – these can be adapted depending on some of your own personal short term and long term plans
- Retirement – this can be in the form of a retirement fund or your own private investments
Q: What are some savings targets I should aim for?
Although there is no ONE answer to how much you should have in savings, here are some common guidelines that you can use in order to decide for yourself how much to save:
- 1 Full month of expenses
- 3 Full months of expenses
- 6 Full months of expenses
- 1.5 times your expenses by 20
- 1 -1.5 full year’s salary by 30 / 1 -6 x your expenses
- 2-3 full year’s salary by 40 / 4-10 x your expenses
- 5-6 full year’s by 50 / 7- 13x your expenses
- 8-11 fully year’s in your 60s / 10-20x your expenses
- Sources: https://www.financialsamurai.com/how-much-should-you-save-by-age-30-40-50-or-60/ and https://www.forbes.com/advisor/kstoller/2019/04/01/how-much-should-you-have-saved-by-age/ https://www.cnbc.com/2018/09/27/heres-how-much-money-americans-have-in-savings-at-every-income-level.html
- According to David Bach you should have 1x your salary by 30, 2x your salary by 35, 3x by 40, 4x by 45, 6x by 50, 7x by 55, 8x by 60 and 10x by 67.
Q: paying off debt, savings, retirement funds, investing… what should I be doing?
In order to truly cover yourself in all financial areas, you want to be doing pretty much everything. But of course, you’ll likely not have heaps of money available to do all at the same time to the maximum amount that you’d ideally set aside. So what should you be focusing on? Here’s a helpful guideline that you can use and adapt to make it work for you.
- Start doing ALL of the above, but start small with those that are less of a priority right now (for example investing) if you still have other ones that are more urgent (paying off consumer debt or saving at least 1 months of expenses).
- Decide how much $ you can put aside each month, then allocate a % of that money to each of your savings, for example: 70% paying off debt, 15% saving, 10% retirement fund contributions and 5% investing.
- Every 3 months, re-evaluate your % as well as your monthly total amount you can save and re-adjust where possible. You might decide that once you’ve paid off all your consumer debts with an interest rate of over 4%, you reduce your % to pay off debt to just 40%, using the remaining 30% to boost your savings or to one or several of the other saving goals you have.
- I’m a huge fan of scheduling dates as those three months will otherwise fly by and be forgotten about, so block in this appontment with yourself already!
Q: Where should I start?
- Begin by putting away a set percentage of your wage. If you need to begin small then that’s okay. This could be 5% or even just 3%. It’s better to start small than to not start at all.
- Set saving goals and if possible open different bank accounts for each one. Saving goals can be anything from short to long term.
- Decide on your savings allocation for each goal: Of all the money you set aside each month, set aside 50% for goal A, 30% for goal B, 10% for goal C and another 10% for goal D for example.
- Little by little start increasing your savings rate, until you get to your ideal savings percentage..
This article is part of the “10 Common Question series”, where I address issues about some key financial areas, including Financial Independence, paying off debt, increasing your income, retirement provisions, saving, investing, financial protection and much more. If you want to find out more about Financial Independence, you can sign up to my newsletter to stay up to date or get a free sample of my book 100 Steps to Financial Independence.