Not Rich Yet | Managing higher incomes

May/10

3

How much should I save?

One of the toughest questions you need to answer – regardless of your income – is how much of your income you should save?

5%? 10%? 50%? What is the right answer? If your “hard” expenses are close to your net income, you won’t have much choice in the matter, but if dialing your “fun” spending up or down moves your savings rate a lot, you should take a look at the graph below.

This is a simple analysis I ran to see how many years it would take assuming a fixed savings rate, inflation and investment return rate to build up a nest egg that exceeds 20 times of your annual net income adjusted for inflation. Why 20 times your net income? Well, that is a reasonable rule-of -thumb value for a retirement nest egg that has a good chance of not running out of steam before you do.

This graph shows that saving early and a lot is a good thing.

Under a moderately conservative scenario of 2% inflation and 8% pre-inflation investment return

  • Saving 10% of your net income per year will take you 44 years to save up that 20x income nest egg
  • Saving 40%, will take you 23 years
  • Saving 60% will take you 18 years
So if you can only save 10% of your income, you better start at 21 so that you hit the magic number by 65. But if you have an higher income, cranking up your savings from 40% to 60% by reigning in your expenses, would allow you to retire 5 years earlier.
What is the right answer? That depends on your goals and circumstances. But think about it carefully…

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5 comments

  • George · May 8, 2010 at 19:00

    The high-savings rate end of your graph is wrong because it’s not the income that needs to be replaced, just the expenses. See Early Retirement Extreme for why a 75% savings rate gets you financially free in 5-6 years.

    If you’re only saving 10-15% of income then yes, it’s nearly the same as replacing income, so it takes an extra long time.

    Reply

    • Admin comment by Jake · May 8, 2010 at 23:33

      Well that depends on whether your savings rate is sustainable. If you are cutting corners everywhere and eating Alpo to make your desired savings rate, you may not be able to sustain that into retirement.

      Also, healthcare costs will increase with age and so will other costs, so I think that replacing income is the better approach.

      Reply

  • 7 financial metrics to use to manage your life · Not Rich Yet · May 11, 2010 at 10:51

    [...] How much should I save? More sponsors Disclaimer Anything published on NotRichYet.com is for information and entertainment purposes only and does not constitute specific advice. NotRichYet.com is intended to provide general information only and does not attempt to give you advice that relates to your specific circumstances. [...]

    Reply

  • Concojones · May 14, 2010 at 07:11

    First, kudos to Jake for coming up with this excellent graph.

    I think both of you (Jake & George) have a point. Taking George’s suggestion into a account would make a pretty spectacular graph. But as Jake says, it’s good to have some margin to cover unexpected costs.

    Reply

    • Admin comment by Jake · May 14, 2010 at 08:55

      I promise there will be a Part II to this post, showing different approaches. That should satisfy all.

      Reply

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