This is a tricky question, especially because there are a lot of factors that impact how much you should save from your paycheck. How much you make, your financial goals and your lifestyle are some of the things that can affect your savings behavior. However, there are some simplified ways to look at this question.
Saving money can be challenging. Putting money aside for future needs from each paycheck, on the other hand, can be a crucial aspect of a well-rounded financial strategy. This article will offer some guidelines in case you are trying to figure out how much from your paycheck you should be saving. You will learn to identify how much you should be saving from your income based on your financial goals, income, and living expenses.
Of course, the article will present simplified methods. These methods might be exactly what you were looking for, or they can serve as a starting point for your savings plan. Regardless, always take into consideration your income, financial situation, goals, and needs.
Regardless of which method you choose to use to grow your savings, all of them have something in common: define your financial goals. This doesn’t just make saving money more tangible, because you know what is coming out of the effort, but it also helps you define how much you should be saving. Financial experts recommend you divide your goals into three main timelines:
These are your short-term savings. By building savings for the next 1 year of your life, you will be able to plan in advance for a last-minute vacation, buy holiday gifts, or even pay your taxes, without messing up your budget. You will basically be planning these eventual expenses in advance, which will allow you to avoid credit card debt.
This is a medium-term type of savings. It can be divided into two main types of savings.
One is for larger unexpected expenses that everyone eventually has. In other words, an emergency fund. This will allow you to pay for car repairs, treatment for an unexpected health issue, or just keep you afloat when you are in between jobs.
The other type of medium-term savings is planned expenses. For example, making a down payment on a home or paying for your children’s higher education. These are large expenses you can know you will have in the medium-term and that requires you to plan ahead in order to have enough money for them.
The ultimate long-term savings goal is retirement. It is never too early to start saving for your retirement, especially if you have plans to retire a little earlier than average. Defining the lifestyle you wish to have during your retirement years is extremely important, because it will directly affect how much and for how long you will be saving money for it.
Now that you know your goals and in which timeline they fit, it is time to take a look at some methods to define how much of your income should be going towards savings. There are some cut-and-dry methods that, as simple as they look like, helped a lot of people grow their savings. Some of these might fit your financial lifestyle better than others. Still, all of them are recommended by different experts and can be a great start if you are not focused on building your savings yet.
This very well-known method to determine how much of your monthly income you should save. The name of this rule says it all.
A maximum of 50% of your paycheck should go toward necessities. These are the monthly expenses that you can’t live without paying, such as:
If you can dedicate less than 50% of your income towards necessities, even better. But try not to pass this percentage.
Then, the rule states that 30% of your income can go toward discretionary expenses. These are your wants, everything you spend money on that isn't absolutely essential. Some examples of wants are:
In this category, you can also include some lifestyle upgrades you decide to make. For example, if you buy a fancier steak instead of a cheaper hamburger, or take an uber black rather than an Uber X, or buy a Volvo instead of a more affordable Honda. Wants are essentially all the small extras that you spend money on to make life more comfortable, enjoyable, and entertaining.
Finally, according to this method, you should allocate 20% of your net income to savings. Keep in mind that savings don’t mean only leaving money in a savings account. You can have your savings in the format of investments. What matters is that this 20% is not being spent on things that won’t bring you financial growth back. So, this percentage should go toward:
This is the one category that passing the percentage is fine but having less than 20% is not ideal.
Another method used to calculate how much you should save from your income is the 4% rule. It claims that you could potentially remove 4% of your main balance each year and live on it indefinitely. To become financially independent, you will need to save 25 times your yearly costs. (If the arithmetic doesn't add up, remember that 25 times 4 is 100, and 100 percent equals your entire amount.)
Of course, there are flaws with the 4% criterion. For starters, there are currently no risk-free investments that earn anything near 4%. Inflationary shocks might potentially be an issue. To account for this, and for the sake of simplicity, you can calculate how much you need to save based on your gross (pre-tax) income rather than your costs. A good way to go around that is to suppose you will save 25 times your yearly income rather than your annual spending. By default, you'll be saving more than you need (since you'll be able to stop saving once you're financially independent).
You can actually mix the 4% rule with the 50/30/20 rule. For example, based on the 4% rule, if you save 20% of your income per year, you will take a little over 40 years to achieve financial independence, which means retirement.
Don’t worry. Saving something is better than nothing. Many specialists believe that 10% is enough savings, especially if you live on a tight budget. Yes, everyone should aim for 20%, but not everyone needs to hit that target on their first try.
Begin small. Begin with one percent. When that no longer hurts, increase to two, or perhaps three. Maybe you made it to 5%, which is a nice achievement. Perhaps you take a 10-percent risk and find yourself anxious and strapped, so you back off. It's a process. It’s better to be consistent and slower than going too radical in the beginning and dropping savings because it didn’t work out for you.
Just try to keep the 20 percent target in mind at all times. It will help you avoid becoming complacent. Increase your savings rate if you earn a raise! You didn't miss that money before, and you won't miss it if you never grow used to having it.
Automating your savings is another great solution to make the process easier. By sending a percentage at the beginning of the month toward savings, it will become easier to resist spending these earnings.
It's difficult to know how much money you should be saving in order to have a secure financial future. The good news is that you don't have to do this task immediately. It is a process, and you should work toward your savings goals based on your needs and financial situation. Over a period of years or decades, you may cross off your savings objectives one by one.