Tuesday, August 12, 2008

How much is enough to save?

Before I go further on this, I want to stress that to start saving you have to pay down your debts. No exceptions. With a growing balance in your emergency fund or savings account, you may feel like you’re coming out ahead, but that number means nothing if you’re taking your time to pay off interest-saddled debt. The longer you take to pay off your debt, the more money it will cost you in the long run and the less you truly end up saving. Simple! I’ve said that before but I felt I had to rinse and repeat. Debt (mostly credit cards) = bad, pay off ASAP. Saving = fabulous, do so when you’ve paid off (at least a large portion of) your debt.

With that aside, how much is enough when you’re saving? The real answer to that question is what, specifically, are you saving for? I, for example, am saving for a house, but in the more long-term, an early retirement. So how much is enough? “They” say that 10% is a good rule of thumb. Unfortunately after extensive research, I still can’t figure out who “they” are, but I guess “their” ominous title affords them some sort of credibility, especially since the Wall Street Journal backs that benchmark.

Personally I don’t think 10% is enough to retire on, especially if you want to retire in style. I’m not saying I need my own private jet, but my dream after I retire is to travel wherever I want, whenever I want -- to the distant lands of India, to the mountains of Argentina, to the vineyards of Tuscany -- and I want to save enough to make that dream a reality. I have a creeping feeling that the 10% benchmark was created decades ago, but with people living longer these days and assuming higher health-care costs, I think the benchmark is a tad low. At the same time, I completely understand that saving is not an easy thing, even 10% for many is literally impossible with the constant barrage of bills, loans to pay off, rising food and gas costs, etc. etc. But, alas, no one said this was going to be easy!

To give you an idea of how much we’ve descended as savers, according to Newsweek, the average American household owes 20% more in debt than it makes each year. Statistics from the Bureau of Economic Analysis (BEA) in February showed that Americans are only saving 0.3%, or $0.30(!) out of every $100 they earn. For a historical look at how us savers have stacked up in the past, just take a look at the average national saving rate for the following years (all courtesy of the BEA):
  • 1944: 26.1%
  • 1964: 8.8%
  • 1984: 10.8%
  • 1992: 7.7% (and from here it's been a spectacular drop into the red)
  • 1993: 5.8%
  • 1999: 2.4%
  • 2003: 1.4%
  • 2005: 0.5%
Oh how the mighty fall. It’s all so bleak, it could almost be lifted from the pages of a Dickens’ novel! Granted, we are in the midst of a subprime mess and downright dreary credit crunch, but how did we get to the point of where our current national savings average is on par with what it was during the Great Depression? My theory is that all too often, many of us fall back on credit and end up unable to climb out of the hole once we're sucked in. Once that happens, well, say aurevoir to saving anything. As I mentioned earlier, it's impossible to save if you're consistently deep in debt. And if you can't save, then how will you live lavishly post-career or achieve any other sort of financial goal, such as buying a house? (Hint: The larger the down payment you save, the less you will end up owing in interest on your mortgage, and therefore, the less debt you will incur.)

After you’ve tampered down your debt, consciously be aware of where your money is going. Do you give in easily to retail temptations? Or is your vision of your future house, college degree, or remodeled kitchen more of a palpable soufflĂ© for your mind? Think of things in terms of consumer-oriented items versus income-generating ones.

But I digress. Going back to the 10% cliche, consider this: People are living longer than ever. With living longer comes more health-care costs, more time to enjoy recreational hobbies (such as traveling, etc.), and more funds that will need to supplement your lifestyle for the long haul. Will there be dependents in your future (aging family members, children, etc.) who you will also need to remember when you do your weekly grocery shopping trip or pay the monthly heating bill? Add to that the fact that social security may not be the spoonful of sugar it was intended to be for many of us when we'll be ready to receive it, and you'll quickly see why saving -- more than just 10% -- is so imperative.

Ask yourself other questions also, such as do you plan to work a 9-to-5 salary job for the rest of your career? Or did you want more flexibility throughout your life, such as to freelance, or work on commission? These are factors that will not only affect whether you're able to pay your mortgage and grocery bills, but also how much you'll be able to save at that time in your life.

If your standard of living is exactly the way you like it (or near close to it!), would that same lifestyle translate well into a future you didn't really plan and save for? If wine tasting, for example, is your passion right now, have you considered whether you could still foot the bill for such a passion if you retire early?

As kids, we used to say what we wanted to be when we grew up with revered certainty that it would happen. Some wanted to be astronauts, some actresses. At one point (I was 5), I said I wanted to be a smurf. Well those same musings often trickle into our more adult, financial lives in the forms of "I'll retire when I'm 50" or "Once I save a million bucks, I'll retire." You get the picture. But behind many of these all-too-often-used adages, there lacks a real budget or financial plan to achieve said goal, much like I lacked a plan to become a smurf.

I've written before that another benchmark people like to throw out there for saving for retirement is the good ole 70% of your "pre-retirement income" benchmark. Are you sure that 70% of your pre-retirement income will be enough to have you basking on the beaches of Turks and Caicos? Or if fancy cars are your thing, will you ever get to toodle around town in that vintage '67 Porsche (a la Robert Redford) you always wanted on 70% of your pre-retirement income?

As I've mentioned a handful of times already, beginning your savings nest egg at a younger age truly benefits you. The younger you start, the more time your money has to grow. According to a 2005 article in U.S. News & World Report, people who start "saving in their 20s should save 10% to 15% of their gross income for their entire working life." If you wait to start saving until your 30s, then that number increases to 15% to 25% of your annual salary. Wait until your 40s, and you'll need to save 25% to 25%, and so on. Why? Because the older wait to start saving, the more you'll have to save to make up for all the time you lost when you were spending it.

Lastly, ask yourself this: How much do you currently earn, and how much do you figure you'll need every year (including the banal barrage of bills, etc.) to sustain a comfortable retired life?

Which brings me back to the original question: How much is enough? Unfortunately, there is no tidy "10%"-type answer. It all depends on the individual variables in your life, and your responses to the aforementioned questions.

Begin thinking about your answers to these and many other self-reflective questions you may come across and calculate approximately how much you think you'll need to start saving now to be able achieve your goals. If that's not "tidy" enough to assuage your current financial stress over your future, try using CNN's "What You Need to Save" calculator, a fun and quick way to see how much you'll need to save up annually if you want to retire at 65 with 80% of your pre-retirement income.


Anonymous said...


I actually just wrote a post a few days ago called, Why I won't save for an emergency fund.

People have been relatively polite about it but most end up proving my point: Saving money for future potential emergencies, while paying high interest on current debt, just makes no financial sense.

That said, debt reduction is all about psychology (as Dave Ramsey's success has proved) and so some people do better ignoring the hard numbers and instead keeping a cushion in the bank while working to pay down debt.

Still, it makes you wonder... I just finished looking at a blog where a woman owes about $8200 on her credit card, but also shows she has $3000 in the bank.

Crystal said...

Yes, I agree that when it makes people feel better about keeping a safety cushion, but if there's high debt involved too, you'll just end up paying more in the long run by not paying it down as fast as you can!

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