Not Rich Yet | Managing higher incomes

TAG | Saving

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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