Your ‘Savings Rate’ – defined as the percentage of your income that you set aside for long-term investments – is a huge driving factor of your long-term financial health. In your financial journey, you can’t control how the stock market performs or how the job market rewards you for your work. But how much of your income you save is mostly in your control. The big question that many people have – how much do I need to save to build a strong financial base and retire comfortably?
Some US financial advisors have popularized a rule of thumb known as the 50/30/20 rule. It says to divide your after-tax income into three parts: spend 50% on your needs (rent, groceries, utilities, food, medical expenses etc); 30% on your wants (movies, new clothes, vacation etc); and set aside the remaining 20% for the future. If you want to retire much earlier than the typical age of 60, you can save even more and achieve ‘FIRE’ (Financial Independence, Retire Early).
We have a different take on savings rates. We believe that setting high savings-rate goals can cause people to give up too early in their financial journey if they are starting far below these rates. According to us (and mathematics), the initial savings rate is much less important than the growth in your savings. That’s just how compounding works!
Today you may save only 5% of your income, but if you can grow your earnings well (at say 15% annually) and grow your spending at the rate of inflation (say 8%) for 5 years, can you guess your savings rate after 5 years? It will be 31%! Over long periods of time, keeping the growth rate of your expenses low and working hard to maximise your income is the real magic trick of growing your savings rate – not aiming for percentage targets like 20% or 30%.
